The Federal Reserve hiked interest rates for the seventh time in 2022 on Wednesday, increasing its benchmark rate to 4.25-4.50%, a 15-year high. The Fed’s rate increase of 0.5 percentage points was smaller than the last four rate increases. The gold market traded above the $1,800 level after the Fed news and the current environment for gold is positive.

• Over the past two months, gold has soared 10% higher, trading from a low at $1,638 in early November to above $1,811 this week, and the trend points to more gold gains ahead.

Despite the Fed’s aggressive rate hike campaign this year, consumer inflation remains sharply elevated at 7.1% in November. While that is down from the 9% pace in June, inflation remains well above the Fed’s stated 2% target rate.

Fed’s Big Inflation Mistake

Inflation took hold in the spring of 2021 and accelerated quickly in the months that followed. At that time, the Fed incorrectly called inflation “transitory” and failed to act last year to stem the rising price trends.

The red-hot inflation levels create financial challenges for Americans across all income spectrums and the Federal Reserve has yet to tame high prices. The Fed has driven interest rates higher for everything from home mortgages to car loans to credit cards, and many Americans say they’ve reduced their holiday spending plans this year due to the runaway higher prices.

The Federal Reserve’s interest rate hikes also contributed to the plunge in stock market prices in 2022, with both stock and bond markets showing double digit declines year-to-date.

Inflation Isn’t Even Close to Being Over

While some categories like used cars and airline tickets fell in November, many consumer items saw continuing price increases. Grocery prices, dining out, recreation services (like tickets to sporting events) and prices for haircuts and other personal care services all increased. Wage inflation is also appearing amid the tight labor market which, in turn, creates conditions for a wage-price spiral, as higher wages fuel even more increases in consumer goods and services.

Brace for More Fed Rate Hikes…and Recession in 2023

The Federal Reserve’s projections on Wednesday reveal that most Fed policymakers expect to continue raising interest rates next year – pushing the benchmark rate as high as 5-5.25%, which is expected to push the economy into a recession.

Protect and Grow Your Wealth with Gold

With the potential for a Fed-induced economic recession in 2023, the outlook is bright for gold. In the midst of the 2022 inflation crisis, precious metals are among the best performing asset classes of the year. Looking into 2023, Saxo Bank predicts gold will climb to $3,000 an ounce. Before gold climbs even more, consider using current market levels to protect and grow your wealth with an increased allocation to gold.

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Gold Offers Diversification that is Disappearing

Diversification is what prevents catastrophic loss. The problem is that many investors are not as diversified as they think they are. In recent decades, assets have begun to exhibit similar movements which means that one of the most important strategies an investor has is beginning to falter. In fact, between the periods of 1990 to 2000 and 2006 to 2016 cross-asset correlation increased by 33%. This trend puts investors in a difficult position because the market today offers fewer opportunities to diversify investment. Fortunately, gold gives investors a chance to renew their diversification because it is an asset that has had a low or negative correlation with equity indices for almost twenty years.

Gold Offers Improved Liquidity

While US citizens often choose to hold gold as an investment, many individuals in other countries use gold as a way to boost liquidity. For example, it is common for gold owners in India to rely on gold as a source of collateral when seeking a loan. This means that gold owners can often obtain capital faster when they pledge gold which is universally acknowledged as a global currency. For this reason, just over half of investors in India own some form of gold. Moreover, the average Indian household stores 11% of its wealth in gold. Loan issuers can process transactions faster when they have the kind of assurance that comes from gold. The relationship between gold and liquidity has grown since the onset of the pandemic which has left many people seeking access to capital.

Gold Helps Protect Against Tail Risk

Tail risk represents the fact that remote events happen less frequently, but when they do occur they generate an enormous effect on outcomes. The word “tail” is used because it refers to the left and right sides of a normal distribution curve – a bell curve – which resembles tails. This concept is relevant to those investing in precious metals because the COVID pandemic was an upheaval that had a massive impact on all aspects of life, especially finances. It is no surprise that silver and gold delivered returns of 47% and 24% respectively in 2020 when the pandemic began to impact everyday life. These events serve as a reminder to investors that the unthinkable can in fact happen and when it does it is best to be prepared with an asset class that will outperform when tail events occur.

Gold Can Create Stability When the Yield Curve Inverts

An inverted yield curve has preceded the last seven recessions. The current yield curve is inverted which has prompted many investors to reconsider their strategy. The yield curve inverts when investors become pessimistic about the economic setting of the near term. As a result, investors demand a greater return on short-term investments which are seen as riskier. Equity and bond investors are taking the most recent inversion as a warning that they need to broaden the range of assets held in their portfolios. Many of these same investors remember that the value of gold increased dramatically after the global financial crisis that started in 2008 when the Producer Price Index for gold rose 101%. Forward-thinking investors are applying lessons from the past to protect their future.

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It’s human nature to want more. It’s also human nature to not want to miss out.

Students of financial markets history are well aware that, going back hundreds of years, market manias or bubbles, occur time and time again. What is a bubble? A bubble is an increase in asset prices based more on emotion than fundamentals. Bubbles form because of human psychology. But, it’s important to point out that bubbles also form because of Federal Reserve money printing, or easy monetary policy – which helps to inflate the bubbles.

Why do bubbles pop? In recent market history – Federal Reserve monetary policy tightening like we are seeing now in 2022 – has caused bubbles to pop. Here are a few examples.

The Nifty Fifty Bubble. A U.S. stock market bubble formed in the mid-1960s led by the so-called “nifty 50,” these were 50 large-cap stocks on the New York Stock Exchange that investors flocked to because of their high returns. For five years up until 1972, the nifty fifty stocks returned nearly 28% per year and over 43% in 1972. That compares to S&P 500 returns averaging about 6.7% for those five years, and a return of just under 19% in 1972.

Why did this bubble pop? The Fed began hiking interest rates aggressively to combat inflation.

U.S. Housing Bubble. During 2001, the Federal Reserve cut interest rates 11 times, pulling the benchmark rate down to 1.75% from 6.00%. This opened the door for one of the greatest housing booms in American history. From 2002 through 2005, housing prices across our nation skyrocketed as homeowners and builders took advantage of ultra-low rates. The housing bubble grew more complex as institutional players got involved with risky and complicated investments based on mortgage-backed securities.

Why did this bubble pop? As the Fed began to hike rates throughout 2005-2007 that deflated the housing market, which only worsened with the 2008 financial crisis.

Cryptocurrency Bubble. The debate is still out on whether the current cryptocurrency market is indeed actually a bubble and we won’t take sides on that issue here. There is still a case to be made for blockchain technology and the future of fintech. However, many cryptocurrency investors in 2022 sustained devastating losses, depending on when they bought into the market. Bitcoin prices are currently hovering around $16,500, that’s down from over $64,000 in November 2021. Like other examples, the Fed raising rates in 2022 has had an impact derailing the massive gains in the crypto market.

U.S. Stock Market. There are many who argued that the broader stock market itself was in a bubble during the multi-year run-up into the January 2022 high – fueled by years of the Fed’s near zero percent interest rate policies. Now, here we are – after six interest rate hikes in 2022, the S&P 500 is down 16% and the NASDAQ composition index is down 29%.

Your Playbook to Surviving Bubble Booms and Busts

Emotions are part of investing. When it comes to bubbles, investors learn a hard lesson about speculation. There’s nothing wrong with speculation. A lucky few can get rich that way. However, when you are speculating you can lose up to 100% of your investment.

The path to long-term wealth building may not be sexy, but it is a proven method, and that includes diversification into non-correlated assets like physical gold and silver. Throughout history, gold has served investors well – acting as a safe-haven investment and store of value. Portfolios that include an allocation of gold perform better than those without. If you want to speculate with a small portion of your portfolio, recognize it for what it is – speculation.

Conversely, when you buy physical gold you are investing in a proven asset that has been a store of value for thousands of years.

Gold remains one of the best-performing asset classes in 2022 – down 5%. Compare that to the 16% decline in the S&P 500, the 29% decline in the NASDAQ composite index, and the 13% decline in the iShares Core U.S. Aggregate Bond ETF (AGG), which tracks the U.S. investment grade bond market.

The Fed isn’t done hiking interest rates. That means the stock market bubble from the past several years isn’t done deflating. Stocks have further fallen and gold has been climbing over the past month. Before the stock bubble pops even more – consider using current market levels to protect your wealth with an increased allocation to gold.

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Is the inflation crisis over? When the government reported the October consumer price index (CPI) rose by 7.7%, slightly less than expected – the Dow Jones Industrial Average soared 1000 points on the news.

Despite the stock market’s jubilant reaction, the inflation fight is far from over, according to a new research paper.

Consider this.

• Before the October CPI reading, that inflation measure registered 8% or higher for seven consecutive months.
• The annual CPI hit 9.1% in June, marking the largest advance since November 1981.
•  Overseas, the British just saw news that U.K. October CPI inflation hit a new 41-year high at 11.1%.
• The Federal Reserve’s inflation target stands at 2%. So, the October CPI is still 5.7% higher than the central bank’s goal.

While the stock market day traders pressed the “Buy” buttons on their online trading platforms the day CPI was released, history shows us that inflation is not that easy to erase.

High Inflation Historically Lasts 10 Years

New research shows that when year-over-year inflation climbs above 8%, like we saw for seven months in 2022, it doesn’t recede quickly, according to a paper from Rob Arnott, Research Affiliates founder and Omid Shakernia, a partner at the firm who leads its multi-asset strategies.

Their research found that inflation above 8% means that inflation tends to accelerate 70% of the time. Using data from 14 advanced economies going back to January 1970, they found the median time it took for those 14 economies to get inflation back down under 3% was 10 years. That’s right a full decade.

Don’t expect inflation to just quietly go away in 2023.

Inflation is now broad based across both goods and services in our economy. Once consumers are paying higher prices for these items and services, companies don’t just cut their prices. Why would they? Higher prices are more profitable for the companies. Giant corporations are now making record profits on the heels of increasing prices.

Here’s what CEOs have said recently on their earning calls.

Kroger CEO: We view a little bit of inflation as always good in our business, and we would expect to be able to pass that through.

AutoZone CEO: And as I’ve said before, you know, inflation has been a little bit of our friend in terms of what we see in terms of retail pricing.

Hostess CEO: We’re also seeing the consumers experience a lot of disruption. And they haven’t fully recognized there were absorbed pricing.

Wages have been rising. This has the potential to keep inflation on an upward trend.

In the second quarter, wages jumped 5.1% annually. Sure, that is below the inflation rate but worker pay is growing at the fastest clip since the data reporting began in 2002.

What does this mean? Economists call this a wage-price spiral. It’s like a feedback loop. A wage-price spiral is when higher prices cause workers to ask for higher wages, which in turn increases costs and pushes prices still higher, setting off a recurring loop of events.

Money velocity is moving higher. After falling for 25 years, money velocity has turned higher.

What is money velocity? Here is how the St. Louis Fed defines it:

“The velocity of money is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy.”

“Higher rates usually pushes velocity up as consumers look for opportunities to deploy their cash. Recently, we have seen an acceleration in money velocity. If this continues, inflation might remain elevated even if money supply falls,” Carlo Putti, fixed income investor director at the fund manager M&G told MarketWatch.

What does this means for gold?

History shows us that high inflation is likely here to stay for years. In 1979-1980, inflation was growing out of control and the Fed had simply lost its grip on controlling inflation. Then, gold skyrocketed to about $850 an ounce, equal to more than $3,000 today.

History is now repeating itself. Fed literally sat on its hands during 2021, failing to act, while inflation climbed to 7%, a 39-year high. The central bank is raising rates now – but once inflation gains traction it’s hard to eradicate as history shows.

As the economy slows and inflation remains high, gold historically has been one of the best-performing assets. At Blanchard, we recommend investors allocate 10-15% of their investment portfolios to gold. If you haven’t yet, consider doing it soon.

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