Gold Scoffs at Fed Baby Steps

Another day, another 17-year high for the yellow metal.

With the recent price action of gold, we find ourselves increasingly unable to resist writing regularly about what Keynes called a "barbarous relic". Some time ago, while deriding former Fed vice chairman Alan Blinder for making some particularly dumb statements on CNBC, we coined the phrase "like kryptonite to central bankers" to describe atomic number 79 and its relationship to the hubristic stewards of the world's all-paper currencies.

That was fun.

It's easy to confuse the five-year gold chart with a five-year chart of California real estate prices - both have about doubled in price during that time. They are both getting increasing press coverage as well, but it's fair to say that the similarities end there.

One has been getting poor reviews of late since it seems to have so many conditions attached to it - credit, debt, interest rates, lending standards, crowd psychology. The other just sits there waiting for the world to give it a new, higher price as another day goes by and a bit more shine comes off of the world's western economies.


When this essay was loosed on the world a short time ago, the discussion of the gold price was centered around the $450 mark. Today, very few people mention $450 and "gold price" in the same sentence. Today, the discussion is of $500 and beyond.

We've yet to hear the phrase "gold bubble". It has a strange sound to it, but, strange in a good way.

Lately, what has been so fascinating about atomic number 79 is that it is now charting a course of its own - thinking independently, as it were. Looking at a one year chart of gold, it is clear that in the last few months, it has been thinking about going up.

What is most intriguing about gold's recent rise is that it has started moving independently of the U.S. Dollar. Gold, priced in dollars, used to be the anti-dollar - rising with the Euro, Yen and other currencies of our trading partners, when the dollar fell.

Now, the dollar holds steady or rises against other all-paper currencies, while gold charts its own course - independent and rising steadily against all man-made money. After spending much of the spring and summer pondering its future, gold de-coupled from the dollar after Hurricane Katrina, as seen clearly when comparing the one-year gold chart above and the one-year dollar chart below.


It's not clear where the price of gold will go in the near term, but it is clear where short term interest rates are going - up. Why? There is much talk about inflation these days - about energy prices passing through to "core" inflation. Amidst multiple asset bubbles in recent years, the worst case scenario appears to be unfolding in front of the eyes of the monetary policy makers - prices that they measure are starting to rise.

To combat this menace of inflation, this disease, as some central bankers are now wont to call it, interest rates must be raised! The board members of the Federal Reserve are inflation fighters after all - that is their purpose, their reason for being - to assure price stability (again, stability of prices that they measure, not all prices).

As evidenced in this chart of the Fed Funds rate over the last year, this campaign has kicked into high gear - an all-out assault on the inflation tempest.


This bold move of relentless increases of short-term interest rates is largely responsible for the rise of the dollar against other currencies of the world - preserving the value of the currency is the claim.

But, what does gold think?

Not much, apparently - it continues to rise, despite these bold interest rate moves. Why is gold not cooperating? And, what of other prices - oil, gasoline, medical care, other services - why are they not heeding their masters at the central bank?

In this next chart, a 25 year timeline of Fed Funds rate, we get an inkling of how perhaps the job of containing inflation might be a little more difficult than many thought just a few months ago. The most recent inflation-fighting campaign is circled in red at the lower right.


When viewed in a broader sweep of time, put into its proper historical perspective, maybe these recent rate increases just aren't enough - maybe these rate increases are just baby steps!

And, maybe gold is scoffing at these Federal Reserve baby steps toward interest rate normalization.

Perhaps gold views recent short-term rate increases as a small, and too-slow-in-coming, downpayment for what ultimately must be paid to keep the all-paper currencies alive and well a bit longer - to control the inflation virus that now appears to be spreading.

Gold wasn't born yesterday.

It will be around long after the asset bubbles and all-paper currencies have succumbed to whatever fate lie ahead.

Gold is in not going anywhere, although it may be losing its patience.