Is Yellen trying to show Trump who's boss?

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In our December Gold Top 20 we said that the real yields were likely to be a key driver for the gold price for the foreseeable future. While we saw some signs that real 5-year yields had peaked and were heading back towards zero, they have rallied back with a vengeance following the hawkish posture of the Federal Reserve on Wednesday. On balance, Fed officials now see three rate hikes in 2017.

A hawkish Fed has sent real yields soaring, particularly at the shorter end of the yield curve (under 10 years). In the chart below, we have inverted real yields in the blue line. That line is falling meaning that real yields are rising and real return bond prices are dropping. Gold is dropping hard along with it. Until this real yield trend changes, gold will likely not be able to rally short of some type of geopolitical event or economic shock.

Another headwind emerging is moderating money supply growth. The gold price trend has diverged from the money supply trend leaving a gap that should be closed. However, there are two ways for this to happen. For gold, the best outcome would be for it to rally to meet up with continued rising money supply growth. The alternative, which may well be unfolding, would be a collapse in money supply growth to the point where it meets the declining gold trend.

Eventually, we believe that the Fed's hawkish tilt will not be sustainable as it will probably choke off economic growth. Call me a conspiracy theorist, but I believe there is some risk right now that the Fed is trying to show incoming president Donald Trump who is boss on the monetary policy stage. A more mainstream interpretation of the Fed move is that the central bank now sees a greater inflation risk than they did before November 8th. Unfortunately, real wage data released Wednesday does not fit with that narrative. For the 12 months ending November, Americans enjoyed a measly 0.5% increase in real average weekly earnings. So if the Fed continues to tighten, expect this to head back down (along with Mr. Trump's popularity).

Perhaps once real wage growth stalls the Fed will reverse course, or at least hit the pause button on rates. At that point, real yields would likely pull back. For gold investors and mining insiders, their best hope is that the market anticipates a Fed policy reversal sooner rather than later.

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