Weak Real Rates: The True Source of Precious Metals Energy Right Now?

inflation vs gold and silver prices

Weak Real Rates: The True Source of Precious Metals Energy Right Now?

Fear of inflation’s dollar-debasing effects understandably sends many savers running for cover behind gold and silver whenever there are signs chronic higher prices are lurking. One of modern history’s best examples of this reaction to inflation took place during the economically tumultuous 1970s. In a period (1970 to 1980) that saw U.S. inflation average 8% and reach double digits on many occasions, gold and silver soared a jaw-dropping 1,500% and 2,100%, respectively.

Precious metals predictably are receiving a close look again from retirement savers as recent spikes in the Consumer Price Index (CPI) suggest meaningful inflation could be upon us once more. It has been roughly 13 years since year-over-year inflation rates have persisted well above the 2-3% range. But CPI figures for April (4.2%), May (5%) and June (5.4%) have many worried that we’re in the midst of something more than mere “transitory” inflation. 

Inflation vs precious metals values have a direct relationship

Indeed, some at the Federal Reserve are so concerned by the numbers that they’re breaking ranks with Fed Chairman Jerome Powell and indicating the central bank may have to begin hiking interest rates relatively soon. St. Louis Federal Reserve President James Bullard recently went as far as to say he sees the first rate hike coming next year.

For his part, Powell is standing firm on the matter of rate increases. The man in charge of America’s central bank has made it clear his bigger concern vis-à-vis interest rates is the nation’s unemployment rate and the anemic economy it implies. The jobless number has struggled since the beginning of the year to drop much below the 6% level. In an appearance before Congress a few weeks back, Powell reiterated he would not be in favor of any upward move in rates as long as unemployment remains well above pre-pandemic levels.

The real interest rate is the rate of interest an investor, saver or lender receives after allowing for inflation.

Powell’s unwillingness to consider rate hikes despite the recent, sharp increases in CPI could have significant implications for precious metals through at least the near term. Presently, real interest rates – nominal rate minus inflation rate – generally are negative, a condition which improves the perception of precious metals in the eyes of long-term savers who see allocations to interest-bearing assets as futile in this climate. Should Powell’s view that rates stay put prevail at the Federal Reserve as inflation continues to rise, those rates likely will become even more negative and further enhance the appeal of gold and silver.

Some experts say there’s an additional force exerting pressure on the Fed to keep rates as they are: debt. Many observers have said the only reason America’s current level of indebtedness remains at all manageable is the record-low rate level. Rising rates would be the proverbial straw that breaks the camel’s debt-laden back, they say, especially considering the Biden administration’s enthusiasm for adding large sums to that debt in the years ahead. 

The prospect rates will remain at or near record lows for the foreseeable future could be very good news for gold and silver. As a matter of fact, one global investment bank recently issued a report in which it declared the outlook for real rates – more than inflation by itself – is the principal reason precious metals will rise in the months to come.

Analyst: “Continued, Necessary” QE Will Prevent Higher Rates

To some observers, debate within the Federal Reserve about whether to raise interest rates implies a luxury the central bank doesn’t really have. In the view, rates will not go up because they can’t; the country’s massive – and ever-growing – level of indebtedness makes higher rates prohibitive.

Debt has to be serviced. Household debt, government debt, all debt. Fundamentally low interest rates in place for well over a decade have allowed both consumers and the government to feel comfortable incurring enormous obligations. Household debt in the U.S. hit a new record at the end of 2020 – $14.64 trillion. And total federal debt currently is at $28.5 trillion and moving higher all the time. 

Indeed, as high as federal debt is right now, it’s poised to rise much higher in the years ahead, courtesy of President Biden’s ambitious agenda. The president’s fiscal outlook calls for record annual budgets in each of the next 10 years, deficit spending at a level of trillions per year, and the federal debt to rise nearly 80% by 2031. 

Anyway, you get the picture – we’re all sitting on a mountain of debt. And with that mountain certain to grow even higher from here, experts such as Chartered Financial Analyst Dan Amoss see no way the Fed can raise rates. Amoss said as much in a recent piece for Daily Reckoning straightforwardly titled “The Fed Can’t Tighten.” 

“The bottom line is that federal deficits will remain extremely high,” Amoss wrote. “In order to fund these deficits at rates that the government (and the broader financial system) can afford, continued Fed QE will be seen as necessary.”  

Amoss added later, “The unsustainable nature of public and private sector spending, savings, debt, and deficits means that a ton of pressure is going to fall on the Fed to plug gaps. The Fed will be forced into a state of more or less permanent ease, almost regardless of the reported inflation rate [emphasis added].”

Amoss is by no means alone in his contention that macro debt is forcing the Fed to sit squarely between a rock and a hard place when it comes to prospective rate increases. Lisa Beilfuss presented the same narrative in a May Barron’s article that illustrated the challenges which face the Fed by detailing the inability of the central bank to tighten even a little three years ago.

You may recall the Federal Reserve kept the Federal Funds rate below 1% for almost a full decade following the 2008 global financial crisis. Then, in 2018, the central bank moved to a mild rate-tightening regime that saw four quarter-point hikes during that year. By December, the Fed Funds rate was only at the still-modest 2.25% to 2.50% range – and yet it proved to be too big a burden for the economy.

“Consider the fact that the Fed was unable to lift rates above 2.5% during the last tightening cycle and had cut rates in several meetings before the pandemic prompted its emergency actions early last year,” Beilfuss wrote. “Since then, U.S. households, businesses, and the federal government have grown only more indebted.”

“The upshot: tightening, via both [Fed asset-purchase] tapering and interest-rate increases, may be much further away than the market currently expects,” Beilfuss later concluded.     

CIBC: “Real Rates Will Be the Bigger Driver” of Metals This Year

Are you surprised to learn just how substantial an impact even relatively modest levels of inflation can have on savings over just a couple of decades? I get it. After all, when we think of economy- and savings-destroying levels of inflation, we tend to think in terms of hyperinflation. Zimbabwe, one of several countries famously plagued by hyperinflation, historically has had to deal with inflation percentages in the millions. As recently as last year, Zimbabwe inflation approached 1,000%.

But as the previous examples clearly demonstrate, you don’t have to contend with such outrageous levels of inflation to have a significant problem holding on to your savings’ purchasing power. You don’t even need to be faced with the double-digit levels of inflation – extremely mild by Zimbabwe standards – that hammered American consumers throughout much of the 1970s and early 1980s. In fact, as we saw earlier, you don’t need much of an inflation problem at all in order to, well, have a problem.

So what can you do about it?

I’ve referenced the 1970s a few times in this piece. The decade obviously is very illustrative of persistent, problematic inflation in American history. But as it turns out, it’s also illustrative of precious metals’ capacity to appreciate in acutely troubled economic environments of which inflation is a prominent feature. From January 1970 to January 1980, gold and silver soared 1,500% and 2,100%, respectively. The decade of the “Great Inflation,” the 1970s, is, in my opinion, one of the best historical examples of precious metals’ potential to strengthen amid a highly inflationary climate.

As I said earlier, I think it’s very unlikely we’ll see inflation reach the heights it did in the ‘70s. By the same token, I think it’s unlikely this time around we’ll see gold and silver perform as they did during the decade of the “Great Inflation.”

But given not only the real-time signs inflation is back but also the Biden administration’s massive spending plans for the next decade as well as the Federal Reserve’s continuing commitment to keeping interest rates at record lows, it’s hardly unreasonable to think we’re in store for chronic inflation at levels on par with those cited in the examples noted earlier. Astute retirement savers will take notes and perhaps recognize precious metals’ potential to mitigate the long-term damage that dollar erosion can inflict on the true value of their hard-earned savings.

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