Why the Fed Will Cut Rates... And Spark a Gold Rally

Editor's note: All eyes are on the Federal Reserve. Its next decision could affect nearly every corner of the market – and legendary gold investor John Doody says it's time to pay attention. Today, he joins us with a piece adapted from the May issue of his Gold Stock Analyst advisory. In it, John reveals why a Fed pivot is nearly certain... and why it could send gold soaring.

Chairman Jerome Powell is finally hinting that he is done...

On May 3, the Federal Reserve made what could well be the final rate increase of this cycle. When the decision came out, Powell said that rates could be near a peak.

Now, it takes time for changes in Fed policy to show up in the economy... So, we believe he will wait to see the cumulative impact of the 10 rate increases that started on March 16, 2022.

This matters for a few reasons – but one is an outcome you might not expect. History shows that if this rate-hike cycle is over, it will likely spark a major gold rally... And the best gold stocks could outperform significantly.

Tomorrow, we'll explain why gold could soar. But today, we'll stick to covering the Fed's next move. As you'll see, not only is a Fed pause likely, but the conditions are in place for the central bank to start cutting rates from here.

Why are we so certain? It's simple.

Two key factors make today's economy very different from the one that was facing us when the Fed began its rate increases...

First, many banks are "sick." They're caught holding bonds they bought when interest rates were down around 1% and 2%. They are now suffering huge – but unrealized – losses, and we don't know how big they are.

Think of the situation like this... Bonds have a fixed annual payment (coupon), and their prices move in the opposite direction of market interest-rate changes.

A $1,000 bond bought in early 2022 that was paying $20 per year yielded 2%. It was attractive then. But now, due to the Fed's actions, a similar, newly issued bond has to pay 5% ($50 a year) to attract buyers. The value of the old bond must fall to $400 for it to yield the 5% needed to attract a buyer.

If the bank can hold the bond to maturity, it would get the $1,000 back, and big fluctuations in the market price of the bond wouldn't matter.

But if bank depositors start demanding their money back, the bank would be forced to sell... and realize a $600 loss.

That's what happened in the recent spate of bank failures, led by Silicon Valley Bank. Many more banks are underwater on their portfolios. All banks own bonds and make loans to earn interest to pay their expenses. Bank credit is a key support for businesses and the economy. If bond-portfolio losses have depleted banks' equity so much that they cannot lend to support business activities, the economy is in trouble.

We don't know how many banks are in this position, as they can classify the bonds as "held to maturity," making them worth $1,000 despite what Mr. Market says. Just as in 2008 to 2009, when 165 banks failed, many banks may need to be saved through Fed-sponsored takeovers by larger banks... such as what JPMorgan Chase (JPM) did with First Republic Bank.

Alternatively, if the Fed lowers interest rates, it would raise bond prices... put value back into bond portfolios... and allow banks to keep lending.

That's a major incentive for the Fed to stop hiking rates today.

The second key change in our economy is the inverted yield curve. When short-term interest rates rise higher than long-term rates, it signals that a recession is on the horizon.

The short-term federal-funds rate is 5.25%, while as of Thursday's close, the long-term 10-year Treasury rate was near 4%... a difference of negative 1.25%. It's a dramatically inverted yield curve. Take a look...

Since 1971, the yield curve has inverted seven times. Each was followed by a recession (shaded in the above chart, which shows this measure since 2000). The current deep inversion will yield the eighth recession.

How does the Fed react to a recession? It lowers interest rates.

Lower interest rates without lower inflation will spur gold (and the right gold stocks) higher. Right now, inflation remains over 4%, far above the Fed's 2% target. That makes gold an attractive store of value and likely to see significant gains ahead.

The next gold bull market is coming. We can't know the precise timing, but with the conditions lining up now, we think it will be soon. And the outcome is certain...

Gold prices will run higher – and drive high-quality gold stocks to triple-digit gains.

It's time to board the gold train to get the biggest rewards. Tomorrow, we'll explain why...

Good investing,

John Doody with Garrett Goggin

Editor's note: Folks who've followed John's Gold Stock Analyst recommendations since 2001 have had the chance to make 20% annualized gains. That's more than double the S&P 500 Index – using just gold stocks. But now, John says it's time to get ready for the next big bull market... In fact, he believes this is the best time in history to own gold investments. Recently, John and Garrett sat down to explain why... Watch the conversation right here.

Further Reading

"Another furious rally in gold is likely to get underway," Chris Igou writes. The metal has been trading sideways for the past two years. But its recent jump has set up a classic technical pattern – one that means new highs are on the way... Read more here.

"When the Federal Reserve began aggressively hiking rates last year, the goal was to cool inflation (and the economy)," Brett Eversole says. Now, though, if we look at the data, that job is done. And it's more proof that the rate-hike cycle is likely over... Learn more here.