Yellen’s Speech At University Of Baltimore And Effect On Gold Price

Last week, Fed Chair Yellen delivered a speech at the University of Baltimore. What can we learn from it?

On December 19, Yellen gave Commencement remarks at the University of Baltimore. She focused on the labor market, convincing the new graduates that they are entering “the strongest job market in nearly a decade”. Indeed, the unemployment rate is at 4.6 percent, which is nearly at level before the recession, as one can see in the chart below.

Chart 1: The Civilian Unemployment Rate from 1948 to 2016.

However, there is one problem with this statistics. The unemployment rate is a lagging index. Therefore, although the decrease in the unemployment rate proves that the US economy has been performing well in recent months, it does not say anything about the future. Actually, the low but not declining level of the unemployment rate may trigger some doubts, as the chart above shows that a bottom in the unemployment rate has preceded almost every recession since 1948. The annual change in nonfarm payrolls in thousands of persons also paints worrying picture, since it has been slowing down recently, just as before almost every recession.

Chart 2: The nonfarm payrolls as change from year ago in thousands of persons from 1940 to 2016.

Therefore, the current enthusiasm about the US economy seems to be exaggerated. Surely, the recent recovery is unusual, hence the bottom in the unemployment rate does not necessarily signal economic problems in the near future. However, investors should remember that government officials and central bankers always paint too rosy picture of the economy. On the other hand, investors should also avoid following opinions of permabears who always make doom and gloom predictions.

Why are writing about this? Well, you will soon see many predictions that the price of gold  will skyrocket to $2,000 or even more in a month or quarter, as the US economy is heading into recession and the US dollar is likely to collapse. Ignore them. They are singing the same song each year. Surely, the US economy is facing many problems and the current expansion last quite long and gold is likely to soar very high in the following years, but not necessarily right away. The truth is that the US economy performs relatively well when compared to Japan or the Eurozone. Therefore, the greenback will remain the investors’ favorite currency, simply because it is the best looking of the ugly sisters.

On the other hand, there are many predictions that gold prices will plunge to or even below $600. We do not say that it is impossible, but these forecasts are often based on the very optimistic outlook of the US economy. It has never been truer than now, as markets believe that Donald Trump alone will lift the global economy up from the swamp of sluggish growth. Yeah, he will boost the US productivity, fix the problem of bad loans in Europe, reverse the ageing population in Japan and reform the China’s economy. Indeed, the current euphoria is intriguing for us, as we do know for sure what Trump will do as President, how he will cooperate with Congress and so on.

And this very important for the gold market, as the recent plunge in the yellow metal resulted from the hope that Trump would trigger fiscal stimulus and boost economic growth. Therefore, although the current outlook for gold seems to be bearish, it relies on that ‘hope trade’. For us, the current expectations are divorced from economic reality and they will be corrected at some point. If these hopes fail, the shiny metal should catch its breath. It could be the case that the bear market will last until the Ryan-Trump’s economic plan is passed through Congress. At this point, the belief in the Trump’s acceleration should peak and the price of gold could find its bottom (assuming that the technical factors also support this outcome).

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Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.