Gold, as an inflation hedge, should continue uptrend

WITH all the chatter about an interest rate hike in December, we thought it would be good to have a better understanding of the correlation of the rate hike cycle and gold prices. Conventional wisdom would have us believe that in a regime of rising rates, the US dollar would appreciate while gold suffers. However, that does not seem to be the case since the start of this current rate hike cycle. In fact, gold bottomed out perfectly one day after the first rate hike in December 2015. Subsequent rate hikes in December 2016 and March 2017 also turned out to be major bottoming points.

One way to explain this price action is how the market tends to price in new information before they happened. Prior to the actual rate hike cycles, gold entered into periods of drawdown as the pricing in mechanism took place as suggested by the Fed Funds Futures. The Fed Funds Futures shows the market-implied probability of a rate hike, and prior to the actual announcement of the rate hikes, the Fed Funds Futures usually indicates a high reading of 70 per cent or more.

Thus, with the current Fed Funds Futures implying 80 per cent probability of a rate hike, we can infer that the market has partially priced in a rate hike in December and a similar bottoming process might happen in December 2017 after the Fed announced the next 25 basis point hike to 1.50 per cent. The date of the December Federal Open Market Committee announcement is Dec 13.