Do Fed Rate Decisions Affect Gold Price Patterns?

Many traders are focusing on gold as the price has contracted over the past 5 weeks and the $1700 level is being retested. This prompted my team and I to research recent US Federal Reserve rate hikes and how gold has previously reacted to rising and falling interest rates.

Exploring Price Patterns Between Gold and Fed Rate Decisions

I knew from the global financial crisis of 2008-09 and the COVID-19 event of 2020 that gold was initially moving lower as extreme selling pressures drove down nearly every asset. Yet, in both cases, gold quickly rebounded and started moving higher more than 5 weeks after hitting a low.

I started my research by describing “normal Fed activity” and “prolonged Fed QE activity” to see if I could identify a difference in how gold reacted to fear and uncertainty in these phases. I thought gold would react more subdued within a price range in normal Fed activity phases, as crisis events and economic uncertainty are more subdued overall. When the Fed enters an expansive phase of quantitative easing, this activity is associated with a US/global economy that requires extraordinary measures to stimulate expected normal capital functions.

I quickly learned that gold tends to stay pretty quiet through Fed rate hikes and cuts in the absence of Fed QE functions. Yet I learned something even more extraordinary about how gold trends under the Fed’s extended QE work: the two-step capitulation bottom.

The Two-Step Gold Setup in Fed QE Activities

This unique pattern seems to be associated with a prolonged scare related to the decisions of the US Fed (and global central banks) to print extensive capital and provide extraordinary capital support to global equity markets and the economy. This does not seem to happen in credit crunch phases. So keep that in mind as we continue to watch global central banks manage future economic concerns.

My belief is that the extensive central bank QE functions are already built into the current gold price model and will continue to drive the two-step model over the next 24 months.

Define the two-step golden model

This pattern is relatively simple to understand when considering the psychology behind price movements. It starts with an increase in the fed funds rate after a long period of falling fed funds rates. When the Fed starts raising rates, gold tends to rally almost immediately. Here are some recent examples:

Each of these stages of gold’s rally was accompanied by a second stage of gold’s rally when the US Fed suddenly reversed course and began to cut the fed funds rate. It looks like this Fed panic is sending a jolt of fear through the markets – driving gold and silver into a potential parabolic price trend if the conditions are right. Here are some examples.

The most recent examples of this two-step precious metals rally pattern occurred in 2008-09 and 1999-2001. The COVID-19 example is still a valid example, but this setup/cycle concluded very quickly as an anomaly event.

The global financial crisis

In 2008-09, after the initial rally phase caused by the rate hike from April 04 to July 06, gold crashed as the GFC crisis of 2008-09 unfolded. Gold quickly returned to near-previous 18-week highs after setting a low. Then gold consolidated for 33 weeks before embarking on an incredible parabolic rally phase – nearly 10 months after gold’s low in October 2008 (see the green arrow rally on the chart of gold below).

Recession

From 1999 to 2001, a similar price pattern unfolded for gold. This time, gold’s bottom set in February 2001, and it took another 67 weeks for gold to rally to near-recent highs before stalling and rising further as the U.S. Fed reacted to the September 11 attacks.

Current Gold Price Action

Currently, gold has crashed to price levels near $1700 after trading above $2000 just a few months ago as the US Fed aggressively raised interest rates to trying to fight inflation. I’m not guessing if/when the Fed will change course, but I believe gold is poised for a very significant rally from any low set by the current two phase price pattern.

If history is any example, this current contraction in gold and silver is most likely a reaction to the sudden event of the inflation crisis and may cause a future price rise in the imagination of anyone.

Some global central banks around the world, Japan for example, continue to push QE in one form or another as the US Fed attempts to raise rates. If the US Fed suddenly turns to more dovish policies, I think a fresh wave of fear will drive gold higher – starting the second phase of the rally.

If the Fed raises rates once or twice before changing policy, it would simply create more momentum for any future breakout in precious metals.

Final Thoughts

As long as there is a quantifiable measure of stimulus or QE in the US, European and Chinese economies, I think this two-step gold-silver expansionary cycle will continue to play out.

We have already seen the first phase of the rally associated with the initial Fed rate hike. Now we are in the price contraction phase where a bottom is going to set in – which may take several more weeks or months. We are waiting for the Fed to ‘break down’ and start cutting rates. This will initiate the new bullish price phase for gold and silver – and possibly send us into another parabolic price phase.

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