The Fed Is About To Cut Rates; What Can We Expect From Gold & Silver?
It's A Precious Question
As the markets try to figure out what the Fed is going to do about interest rates, one group that has unquestionably benefited from the change in conditions has been precious metals.
Over the past year, gold is up 30% to another new all-time high, but even silver has gained nearly 20% itself.
There are a few reasons why we could be seeing such a rally. Gold, in particular, is considered a safe haven asset and, while its long-term correlation to equities tends to hover pretty close to zero (meaning it does pretty much whatever it wants), it does act as a downside hedge more often than not when volatility ticks up. We did get that one spike in the VIX about a month ago, but outside of that, volatility has mostly been contained and the S&P 500 has been retesting new all-time highs. It just doesn’t look like a flight to safety trade yet.
The other primary reason could be its relationship to interest rates. Gold and silver are, of course, non-yielding assets, but when rates fall on instruments, such as Treasuries, bonds and CDs, the opportunity cost of holding precious metals diminishes and makes them look relatively more attractive. Long-term Treasury yields have been volatile over the past year, but they’re unquestionably heading lower. In October of last year, the 10-year yield touched 5%. Today, it’s at 3.8%. That shrinking interest rate differential works in favor of precious metals.
The short end of the Treasury curve, however, is what’s most closely tied to the Fed Funds rate. Long-term rates can fluctuate due to any number of monetary and economic factors, but short-term rates usually reflect Fed rate policy. While the Fed Funds rate only moves when the central bank moves it, the 1-year Treasury yield tends to move in anticipation of what the Fed is going to do.
Right now is a very good example of this phenomenon. The 1-year and the Fed Funds rate at the lower band were both at 5.25% as recently as May. Today, the 1-year yield is sitting around 90 basis points below the Fed Funds rate.
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