The Woman With The Golden Gun

by: Eric Parnell, CFA

Gold has been beaten down as of late.

The threat of another rate hike from the Fed is weighing on the yellow metal.

The response by gold to monetary tightening is actually quite solid in the post crisis period.

This is the part I really like
--Francisco Scaramanga, The Man With The Golden Gun, 1974

Gold has suffered a beating in recent days. In fact, it has been down strongly ever since Chair Janet Yellen the team from the FOMC finally cracked enough skulls to effectively convince the market that its going to raise interest rates next Wednesday. But what is ironic is that the U.S. stock market has remained largely unfazed by these rate hiking prospects at the same time gold has been getting drubbed. For if history is any guide, gold has traditionally shined well beyond its paper based counterpart in the days, weeks and months following a tightening action by the U.S. Federal Reserve.

Fire Away

Although it has been generally true since the turn of the millennium, let's focus on the post financial crisis period since it is the relevant context for the current market environment.

The first hint of monetary tightening after the financial world nearly imploded from 2007 to 2009 came on March 31, 2010 when the Fed brought to an end its QE1 stimulus program. While still believed by some to be omniscient, what those at the Fed did not realize at the time was the sudden termination of large scale asset purchases effectively represented a massive monetary tightening taking place all at once. But while stocks were sent reeling for months after the end of QE1 up until then Chair came running with promises that QE2 would soon be on its way in late August, gold (NYSEARCA:GLD) shined throughout the entire tightening episode in gaining +12% versus the -11% decline for the S&P 500 Index (NYSEARCA:SPY).

Just as QE1 came and went, so too did QE2. And just like after the end of QE1, stocks were quick to move to the downside once the prop of monetary stimulus was stripped from the market. But gold once again enjoyed a fine time until the Fed intervened once again with Operation Twist in late September 2011 in gaining +18% versus the -11% drop in stocks over this time period.

Gold had some tough years during the halcyon days of post crisis monetary stimulus through 2014. But just like the two episodes that came before, the Fed's biggest-of-them-all QE3 stimulus program finally came to a conclusion at the end of October 2014. And while the run proved fleeting, gold (NYSEARCA:IAU) still managed a solid +11% rally in the weeks that followed while stocks (NASDAQ:QQQ) traded generally flat over this same brief time period.

The next big tightening move by the U.S. Federal Reserve came in December 2015 when it finally, FINALLY, raised interest rates by 25 basis points for the first time in the post crisis period. And almost immediately after the rate hike, gold entered into a strong +24% rally that lasted through the better part of 2016. In the process, gold (NYSEARCA:PHYS) more than quadrupled the returns of stocks (NYSEARCA:DIA) from the date of the rate hike through the end of September 2016.

Most recently came the Fed's second interest rate hike in December 2016. And once again, gold took off to the upside after an initial pause, gaining nearly +10% along the way to outperform the stock market to date as of early March.

The Bottom Line

Investors should view any sustained sell off in gold in advance of the Fed's anticipated interest rate hike next week as a buying opportunity. For if post crisis history is any guide, a tightening of monetary policy is not something that has pushed gold down. Instead, it has served as a catalyst to push it to the upside.

How can this possibly make sense from a fundamental perspective? Because gold is an instrument whose price is influenced not only by monetary liquidity but also expected pricing instability (inflation or deflation), the direction of the U.S. dollar, the potential instability of global fiat currencies, geopolitics, safe haven demand, and uncertainty associated with the economic outlook among many other factors. And more often than not, the net of these various forces have favored gold over hindering it during periods of monetary tightening during the post crisis period.

With the Fed angling to raise interest rates in advance of the implementation of any pro-growth policies from the new administration at a time when increasing signs of underlying weakness are bubbling to the surface, the net of such forces may prove beneficial for gold once again the next time around later this month.

Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.

Disclosure: I am/we are long PHYS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.