Peak Lunacy on Interest Rates: Gold And Silver Price Analysis

Since the Iran War began a month ago, the gold price has been hammered backward by nearly 20%. Much of this decline can be attributed to the misguided notion that higher energy prices will lead to Federal Reserve rate hikes in the months ahead. This is lunacy, and we may have hit Peak Lunacy late last week.

Nearly every time he speaks, Fed Chair Jerry Powell likes to remind listeners of the Fed's "dual mandate" to control inflation and promote maximum employment. History has clearly shown that the employment and growth component of this mandate takes precedent to the inflation component. See the Fed's reaction to crises in 2008 and 2020 as examples. 

Both the Great Financial and Covid crises were demand-driven shocks, however, and this current Middle East crisis appears at first glance to be a supply-driven shock. As such, there has been an almost unanimous reaction that the Fed will respond differently this time, choosing to hike rates to control inflation rather than cut rates to promote growth. This idea became so pervasive that, last Friday, the fed funds futures market shifted from an expectation of rate cuts to rate hikes in the months ahead. 

Fed Rate Hike Fears and the Shifting Yield Curve

Economists and traders now expect higher rates due to the supply shock on energy prices, and this is reflected by a 50-60 basis point shift in the yield curve since the war began.  

Why the Federal Reserve Will Focus on Long-Term Demand Over Inflation

While not denying the short-term supply shock, my belief is that the Fed will ultimately focus on the long-term demand shock instead. Before this crisis even began, the most recent jobs report showed a job loss of 92,000 in January. What will be the job losses in March and April as the U.S. economy slows? What will be the impact on the U.S. consumer as spending money declines due to higher gasoline and energy prices? Again, the long-term demand shock is where the Fed will ultimately place their focus, particularly with a new, Trump-appointed chairman coming this summer. 

And don't forget, nothing stops the train. The U.S. is already over $39T in debt, and that number will exceed $40T by the time of the mid-term elections this fall. With over $10T in existing debt needed to be refunded and reissued before year end, the implications of higher interest rates on the U.S. balance sheet are startling. Do you really think Trump's new Fed Head will allow a collapsing economy and stock market to influence the election outcome? 

As such, I firmly believe it's lunacy to think that the Fed will be raising rates later this year to confront possible inflation. Inflation was still 3-4% when it cut rates ahead of the 2024 election, and potential inflation will be discarded as a concern later this year too. 

It seems that others are now coming around to my point of view. Here's Goldman Sachs from Monday morning, March 30: 

If I'm correct about this, the Peak Lunacy of last Friday would likely mark the bottom and lows of the drawdown in the gold price since the war began. Perhaps you can see this on the chart. Notice that price has solidly bounced from its 200-day moving average, and this occurred as the Relative Strength Index hit a deeply oversold level of 27 last Monday, March 23. 

Gold - Daily Candlestick Chart

Gold Price Outlook and COMEX Open Interest Hits Eleven-Year Lows

Additionally, this price action comes at a time of multi-year lows in COMEX open interest. As of last Friday, total open interest in COMEX gold fell to 368,300 contracts. This is down from a recent peak of 555,309 contracts in late January and represents the lowest open interest total since December 2, 2014—over eleven years ago, following the price crash of 2013 and with price near $1400. 

So, to the point of all this.... 

Gold prices will soon begin moving higher again. The Fed is far more likely to CUT rates later this year than raise them, and all of what we discussed in our annual forecast is still in play, namely sharply lower rates, Yield Curve Control, and maybe even an official gold price revaluation for balance sheet purposes. As such, gold investors should remain confident in their planning, and those who continue to dollar-cost average into physical metal will be rewarded. For more context on what this means for silver, read our important week for silver price analysis and follow the latest silver spot price movements.