Investors around the world are awaiting details of the Federal Reserve’s rate cut announcement, which will be revealed Wednesday of this week.
With a weakening jobs market, there seems to be no doubt that the Fed will cut – the only question remains is by how much?
For gold investors, the news may seem welcome. A rate cut means the case for gold as a monetary asset becomes more attractive, because any cut will lower the returns on the main alternative to gold: US Treasury bonds. But I’m not so certain what a rate cut will mean over the short term…
Here’s why:
From my perspective as a gold analyst, I’m very short term agnostic. I think a lot of the recent price action in physical gold and silver, as well as precious metals securities has baked in a rate cut.
In other words: the market has been expecting a rate cut for months.
The news on Wednesday could be a disappointment that sends precious metals into a short term correction – if the cuts are deemed as not big enough.
But if you’re looking for a pat answer to what exactly will happen given a 0.25% rate cut vs. a 0.50% rate cut, I’m here to tell you: no one knows.
I think over the long term, the Fed is likely to drift towards easy money policy. That’s where the tide is headed. But over the next few days, the market is just as likely to dip lower as it is to scream higher.
In theory, rate cuts will strengthen the job market by lowering borrowing costs for employers.
From a practical standpoint: how much of a difference would it make in your household if your borrowing costs dropped by 0.25%? Would you go out and splurge?
Employers aren’t hiring because they’re either already seeing a contraction, or they believe one is around the corner. It’s unclear if a rate cut will make businesses immediately and significantly more profitable to the point they can hire tons of new people – or if an aggressive rate cut will spook people into thinking we must already be heading into a recession.
The good news:
If we do see a correction, it will be a fantastic time to buy my favorite gold stocks at an even bigger discount. For most of the companies in my portfolio, they’re already selling at a discount to their net asset value.
But we really haven’t had much of a breather in gold stocks all year. We saw a big bump through the first few months of the year, and then for the most part, our holdings drifted sideways until a month or so ago when we saw another bump almost across the board.
But a short term reprieve would be helpful…
Remember: we’re in the early stages of this gold bull market. We’re nowhere near the top yet. So you have to look at any minor correction or dip as a buying opportunity. I know that it doesn’t feel great to be buying on weakness, but from a portfolio management perspective, it’s the right move.
Every bull market undergoes period corrections. Sometimes they’re substantial. In the 1970s, the price of gold had multiple corrections – some of them over 20%.
Gold stocks during the 1974-1976 saw an average drawdown of about 70% as the price of gold weakened.
I don’t think we’re headed for this kind of substantial correction just yet: I’m just giving you some context.
Over all, gold stocks were some of the best performing securities to own in the 1970s – even with a 70% correction. The point is: buy quality companies when you can – especially when the market gives you a 2nd chance with a short term correction.
But again: a rate cut could just as likely have the opposite effect, and send gold and gold stocks soaring. We’ll find out in a couple of days.
Best,
Garrett Goggin, CFA
Chief Analyst & Founder, Golden Portfolio
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