The Fed Rate Cut No One’s Expecting

Gold’s down today, but boy will it soar when the Fed announces its next rate cut.

Dear Fellow Investor,

I spent five days in Vancouver last week, pontificating that the gold market was remarkably bullish precisely because it had begun rising again for long-term monetary reasons — and not short-term, safe-haven reasons.

Then...just my luck...a global pandemic broke out and sent gold higher.

I’m not here to join the chorus of “experts” telling you that a global pandemic has broken out and somehow that means you should buy gold right now, and in hand-over-fist fashion.

That was yesterday’s news. It didn’t make sense then, and apparently the markets have discovered that today, as gold is down about $10 while U.S. stocks are erasing much of yesterday’s steep losses.

I think everyone has realized that this year’s edition of the common flu will kill orders of magnitude more people than the coronavirus will. And also that such events are silly reasons to buy gold.

Instead, investors need to buy gold because there are inescapable, irreversible economic trends in place that guarantee much higher prices for gold and silver.

I’ve talked about these in some detail in recent issues, but you’ll remember that they include monstrously large debt levels — encouraged by years of near-zero interest rates — that demand the depreciation of the underlying currencies.

In short, the dollar, foremost of all, will have to be severely devalued.

In this issue, I’d like to drill down a couple of issues related to all of this: The reality that interest rates will remain low essentially forever, and that the Fed is at the beck and call of Wall Street.

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The Fed Rate Cut That Will Shock The World

As I’ve detailed before, the sheer size of the U.S. federal debt, now well over $23.2 trillion and growing at a pace of about $1.5 trillion/year, means that interest rates must not only be very low, they actually have to be lower than the rate of inflation.

That’s because the cost of servicing the debt is enormous — as in swamp-the-entire-economy enormous — at any rate of interest that’s larger than the rate at which the dollar is being depreciated.

The rate of inflation is the accepted gauge of how quickly the greenback is being devalued, so what I’m saying here is that real interest rates (adjusted for inflation) have to be negative.

And we all know that negative real rates are extremely bullish for gold and silver.

But there’s more: The current “everything bubble” is the result of the Fed loosening the purse strings every time the economy has slowed down since the dollar-gold link was severed in 1971.

This has two very important implications.

The first you can see in this chart showing every Fed rate cutting program since 1980.

Look at that stair-step pattern of red lines moving ever lower over time. These mark the lows in the fed funds rate following every recession or economic slow-down.

So where will interest rates end up after the next dip in the economy? In the negative zone, of course.

The second implication has to do with why the Fed lowers rates, and keeps them lower, after every recession. Because in each instance they are not just spurring economic growth, but also blowing up asset bubbles as an unintended consequence.

I say “unintended,” but after the 2008 crisis, blowing up asset bubbles was entirely the Fed’s intention. Their goal was to create the now-infamous wealth effect...boosting the value of consumers’ real estate and stock holdings so they would feel richer and spend more.

They got what they wanted, and then some. Contrary to the old adage, the stock market is the economy these days, and the Fed fears that a serious stock-market decline will bring their whole house of cards crashing to the ground.

Wall Street knows this, and periodically pitches a hissy fit to signal that it wants another rate cut. At the current overly-euphoric, over-valued levels, it won’t take much of an excuse for stocks to begin a significant correction. And you can bet that the Fed will respond with the rate cut that the market is demanding.

Our friend Jim Rickards just predicted a rate cut in June, essentially because enough time will have passed since the last cuts and the market will find some excuse to give the Fed for taking action.

But get this: The next rate cut will not only be unexpected, it will also be dramatic. That’s because the Fed and Chairman Powell last warned that they wouldn’t cut rates unless events cause a “material reassessment” of their rosy outlook for the economy.

This means everyone will take the Fed’s next cut as a sign to mean that things are much worse than they had expected.

And the market reaction will therefore be that much more dramatic.

Of course, the primary market reaction we’re concerned about is how high such an event will send gold prices. I expect it will be very high indeed.

In the near term, I think the Fed’s ongoing foray back into quantitative easing will support the gold rally over the next couple of months, at least. And I predict that the prices of junior gold stocks will advance much more than gold itself.

But longer term — and this could mean as soon as June — it’s inevitable that we’ll see the Fed give the markets another rate cut.

And precisely because no one is pricing that into their expectations right now means you should be.

All the best,

Brien Lundin
Editor, Gold Newsletter
CEO, the New Orleans Investment Conference