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An Interest Hike Doesn’t Mean That Gold Price Must Crash

Summary The Fed chairwoman Janet Yellen stated that the U.S. economy is strong enough for the Fed to start raising the benchmark interest rate. The pace of the U.S. GDP growth and the inflation rate don’t indicate that there is any need to raise the interest rate. Any interest rate hike will be probably only symbolical and it won’t be followed by another interest rate hike anytime soon. History shows that gold and GLD prices often react on the interest rate changes in contrary to the theory and general expectations. Gold price has been in a strong downtrend for the last couple of weeks. The SPDR Gold Trust ETF (NYSEARCA: GLD ) reached a new multi-year low, just shy of the $100 level. It represents a more than 10% decline since the middle of October. The decline was driven by increased expectations that the Fed will raise the key interest rate as soon as in December. The probability was further supported by a very strong October job report . Although the November data are a little weaker and some of the economists, including Peter Schiff claim that the state of the U.S. economy is worse than the numbers show, statements of the Fed representatives still indicate that the interest rate may be hiked this month. According to Janet Yellen, chairwoman of the Fed, the U.S. economy is strong enough for the Fed to start raising the benchmark interest rate. Is an interest rate hike needed? The probability of a December interest rate hike is high, although I don’t see any good reason why to raise it. Yellen explained why the Fed wants to raise the interest rate when she stated : Were the FOMC to delay the start for too long, we would likely end up having to tighten policy relatively abruptly to keep the economy from overshooting. Such an abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into a recession. Yes, the reason is good. The above-mentioned statement makes sense. But the officially-presented data don’t indicate any risk of an overshooting anytime soon. The annual pace of the GDP growth rate is only slightly above 2% and the inflation rate is at 0.2%! Actually, the deflation is much more probable than overheating of the economy, according to the official data. There are a lot of discussions about the accuracy of the officially-presented data. For example, according to John Williams and his website Shadowstats.com , the current inflation rate is close to the 4% level using the 1990 methodology, and it is around 7.5% using the 1980 methodology. In this case, we can start to speak about overheating of the economy. It really seems that the Fed publicly presents one set of macroeconomic data and it makes policy decisions based on another one. (click to enlarge) Source: Trading Economics Moreover, raising the interest rate too much may damage the U.S. economy. The strong USD already has a negative impact on the U.S. exporters. It may also damage the foreign economies, as a lot of the companies around the world have big USD-denominated debts, and they are dependent on revenues denominated in other currencies. As the value of these currencies falls, the companies will have more and more problems with the debt service. There are a lot of reasons why to expect that if there is any interest rate hike this December, it will be only symbolical and it will probably take quite a lot of time before another hike will occur. There are various economists who have the same opinion and they don’t see any good reason to increase the interest rate right now. One of them is Peter Schiff who expects that the Fed will leave the interest rate unchanged or it will raise it by 0.25%. He assumes that both of the outcomes will be positive for gold, as the markets have already factored in substantially more than a 0.25% interest rate growth. How did GLD share price react in the past? Although theory says that GLD price should decline after an interest rate hike and it should grow after an interest rate cut, history shows that this anticipation is often wrong. The financial markets always try to predict the future development, and the interest rate change is often reflected by the asset prices before the rate change itself is officially announced. And if there was a strong trend before the rate change, the trend may get disrupted for some time, although it tends to resume after the dust settles down. 22 interest changes occurred since the inception of GLD. In 12 cases, the interest rate was increased and in 10 cases it was decreased. The table below shows the development of GLD share price 20, 10 and 5 trading days before the rate change and 5, 10 and 20 days after the rate change. It is interesting that on average, GLD price grew before the interest rate change and it was in a slight decline 5 and 10 trading days after the rate change. But 20 trading days after the rate change, it was back in green numbers. Only in 4 out of 12 cases (33.33%), the GLD price recorded any losses 20 trading days after the interest rate hike. It declined by 4.73% on average. On the other hand, in 66.66% of cases, the GLD price recorded gains (5.08% on average). In 4 cases (33.33%), the GLD price just kept on growing, without any reaction on the interest rate hike. After the Fed started to cut the interest rates, GLD was down in 50% of the cases after 20 trading days. After the interest rate cuts on March 18, 2008, October 8, 2008 and December 16, 2008, a strong growth trend turned into a steep decline. It shows that GLD often reacts contrary to the theory not only after interest rate hikes but also after interest rate cuts. (click to enlarge) Source: own processing, using data of Yahoo Finance and the Fed Conclusion If the Fed hikes the interest rate during its meeting on December 15/16, it doesn’t mean that gold and GLD prices must crash. The official macroeconomic data don’t indicate that the U.S. economy should start to overheat anytime soon; moreover, a too strong USD may hurt not only the U.S. economy. Any rate hike will be only symbolical and it will probably take a long time before another one will occur. The markets may actually welcome that the more than a year long saga is finally over, and the GLD price may react positively. As the not-so-distant history shows, it wouldn’t be the first time when GLD price grows after an interest rate hike. Adding to it the problems the gold miners have to face at the current gold prices and the high demand for physical gold, GLD presents an interesting contrarian opportunity.

Beat U.S. Manufacturing Woes With These Industrial ETFs

The brisk momentum in the U.S. economy seemed to have taken a brief halt to start December as the economy’s manufacturing activity for November shrunk to below a six-year low. Contraction in manufacturing activity came after three years. Almost an eight-year high greenback and steep spending cuts in the energy sector to resist the stubbornly low oil prices were held responsible for this dropdown. However, other economic readings and solid auto sales confirmed that the economy is well on its growth path. The Institute for Supply Management (ISM) reported that the benchmark of domestic factory output declined to 48.6 from 50.1 in October. The data missed economists’ expectations of 50.5. Notably, a reading of below 50 indicates a contraction in activity. The measure for new orders slipped to 48.9, more than a three-year low level. The prices paid index dropped to 35.5 from 39 and fell shy of the expected 40. However, construction spending rose 1% to a seasonally adjusted $1.11 trillion rate, which is the highest level in almost eight years. Market Impact Since the offhand data sparked off concerns regarding the economic health of the U.S. to some extent, the dollar fell from its multi-year high level and PowerShares DB US Dollar Bullish ETF (NYSEARCA: UUP ) lost 0.5% on the day. The little confusion offered the gold ETF SPDR Gold Shares (NYSEARCA: GLD ) a short-lived respite as the fund added about 0.4% on the day. The benchmark U.S. 10-year Treasury note yield dropped to a one-month low of 2.15% as of December 1, 2015, giving iShares 10-20 Year Treasury Bond ETF (NYSEARCA: TLH ) a 0.7% nudge. The possibility of a slower rate hike trajectory (if the Fed shoots the lift-off this month) and a slimming manufacturing activity at the threshold of a rising rate environment left investors edgy. However, along with several other analysts, even we believe that this latest blow to ISM data is more the result of the soaring greenback, the one-and-a-half year long oil price rout that handicapped the entire energy sector and lower demand from abroad due to global growth issues. The underlying current in the U.S. economy seems pretty decent. ETFs to Watch Investors should also note that the stocks were fairly steady after the weak industrial data. Still, some investors may want to take a closer look at the industrial ETFs. Though industrial ETFs have underperformed so far this year, they’ve held their head high in the key trading session. Below, we highlight four ETFs which are still strong bets in an apparently-lagging sector. First Trust RBA American Industrial Renaissance ETF (NASDAQ: AIRR ) This fund provides exposure to the small and mid cap stocks in the industrial and community banking sectors by tracking the Richard Bernstein Advisors American Industrial Renaissance Index. The index first eliminates the stocks from the Russell 2500 Index that aren’t connected to manufacturing or related infrastructure and banking. Then it eliminates companies with non-U.S. sales greater than or equal to 25% and positive 12-month forward earnings estimates. For the banking component, only banks in traditional manufacturing hubs will be included in the holdings list. The approach results in a basket of 37 securities, which are widely spread out across components with none holding more than 4.35% of assets. The fund is often overlooked by investors as depicted by its AUM of $44.9 million and average daily volume of about 19,000 shares. The Zacks Rank #3 (Hold) fund charges 70 bps in fees per year and has lost 1.3% so far this year, but was up 0.7% yesterday. ARK Industrial Innovation ETF (NYSEARCA: ARKQ ) This is an actively-managed ETF seeking long-term capital appreciation by investing in companies that benefit from the development of new products or services, technological improvements and advancements in scientific research. Autonomous vehicle is the top industry in the fund with 33% exposure followed by robotics (31%) and 3D printing (23%). This approach results in a basket of about 40 stocks. The product has accumulated $13.8 million in its asset base and charges 95 bps in fees per year. The fund is down 0.5% in the year-to-date frame but added over 0.2% on December 1, 2015. iShares U.S. Industrials ETF (NYSEARCA: IYJ ) IYJ tracks the Dow Jones U.S. Industrials Index to provide exposure to 212 U.S. companies that produce goods used in construction and manufacturing. The fund is heavy on General Electric (NYSE: GE ) (10.7%). The ETF manages an asset base of $605 million and trades in an average volume of 82,000 shares. The fund is slightly expensive with 43 basis points as fees. It rose 0.4% on December 1, 2015 and is up over 0.5% so far this year. The fund has a Zacks ETF Rank #2 (Buy). Vanguard Industrials ETF (NYSEARCA: VIS ) This fund follows the MSCI US IMI Industrials 25/50 index and holds about 345 securities in its basket. The fund manages nearly $2 billion in its asset base and charges only 12 bps in annual fees. Volume is moderate as it exchanges roughly 105,000 shares a day on average. Aerospace has the top sector exposure with 23.3% weight followed by industrial conglomerates (19.6%). The Zacks Rank #3 product has lost 1.6% so far this year (as of December 1, 2015) but advanced 0.6% in the key trading session. Original Post