Precious metals closed lower yesterday, and were broadly lower this morning, with gold slipping over 2% to touch its lowest level since August 2012. Since then, losses in the precious metals space have moderated with gold and silver sustaining losses just shy of 1% as this is being written. The violent move lower in metal prices was precipitated by the release of the minutes from the Federal Open Market Committee (FOMC) meeting in December 2012. It was at this meeting that the Fed announced its intent to purchase $40 billion worth of mortgage-backed securities (MBSs) and $45 billion worth of longer-term Treasuries on a monthly basis heading into 2013. The specific "revelation" provided by these minutes was the contention surrounding the longevity of this latest round of quantitative easing.
The word revelation above has quotations because in reality, division within the Fed's Board of Governors is nothing new. Every Fed decision has left at least a few Board members alienated as the central bank's policy bias conflicts with their opinion of the best course of action. The fact that markets have reacted so dramatically to this "revelation" ultimately amounts to a kneejerk response rather than a structural change to the outlook for precious metals.
Below is the specific verbiage used in the FOMC meeting minutes referencing the projected timeframe for the Fed's newest round of quantitative easing:
In considering the outlook for the labor market and the broader economy, a few members expressed the view that ongoing asset purchases would likely be warranted until about the end of 2013, while a few others emphasized the need for considerable policy accommodation but did not state a specific time frame or total for purchases. Several others thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013, citing concerns about financial stability or the size of the balance sheet. One member viewed any additional purchases as unwarranted.
Given the unprecedented nature of the Fed's recent policy approach, it is certainly not unusual that there will be some division in the timeframe associated with its strategies. With no historical basis or precedence with which to frame their policy decisions, the Fed's Board of Governors will undoubtedly question, second-guess, and ultimately argue over the "right" course of action as they navigate a quagmire of their own design. This uncertainty is similarly highlighted in the FOMC meeting minutes:
Participants discussed the effectiveness of purchasing different types of assets and the potential for the effects on yields from purchases in the market for one class of securities to spill over to other markets. If these spillovers are significant, then purchases of longer-term Treasury securities might be preferred, in light of the depth and liquidity of that market. However, if markets are more segmented, purchases of MBS might be preferred because they would provide more support to real activity through the housing sector. One participant commented that the best approach would be to continue purchases in both the Treasury and MBS markets, given the uncertainty about the precise channels through which asset purchases operated.
The last line, about purchasing both Treasuries and MBSs due to uncertainty about exactly how the knock on effects of said purchases will percolate through the economy seems to be the logic adopted by the Fed given their dual approach to its bond purchasing program. The excerpt above really emphasizes the nebulous policy environment in which the Fed now inhabits. Considering this reality, it makes sense that the central bank hasn't provided definitive guidance on the timeframe for this bond purchasing program. The Board of Governors will have to consistently review the intermeeting economic environment and base its policy outlook and decisions accordingly. It is unlikely that we will be afforded much clarity in this regard in the short-term. More than likely, the Fed will revisit this discussion at future FOMC meetings and provide further insight closer to mid-year.
If you comb through the FOMC meeting minutes, you will be hard pressed to find even one decision in which Board members were in unanimous approval of. With this in mind, the market's rash response to Board member "divisions" on the timeframe of the most recent policy measure (i.e., $85 billion worth of monthly bond purchases) should not distract from the true crux of the issue -- the Fed is printing $85 billion dollars a month. Whether this program lasts for six months, a year, or beyond, it represents a substantial addition to the more than $2 trillion the Fed has already printed since 2008. Once you pass a point of critical mass, it doesn't matter how far past you go, only that you crossed that threshold. It is for this reason that the recent sell-off in precious metals is overblown.
While gold dipped below $1,630 in intraday trade today, it found solid support at $1,625 and bounced back. Prices may hover near the new lows made today, but gold should continue to find support at the $1,625 level as bargain buyers and those gold investors who have not lost sight of the Fed's unprecedented measures take advantage of attractive prices.
Another important consideration is that while the timeframe for the Fed's monthly bond purchases is ambiguous at this point, the Fed has established a numerical target -- unemployment at 6.5% -- before it will begin considering to reverse record low interest rates. The Fed itself indicated its expectations for the current low-rate environment and elevated unemployment (i.e., above its designated 6.5% threshold) until mid-to-late 2015. Gold and precious metals do not need to depend on further monetary dilution for price gains. So long as interest rates are at record lows, the opportunity cost for holding precious metals (i.e., the interest or income you could have realized had you allocated your funds differently) will remain subdued. This will maintain much of the allure provided by metals, even if the Fed decides to cut its bond purchases short earlier than anticipated.
Additionally, even with inflation rates muted, they still exceed the interest paid on most investments, meaning that negative real interest rates will continue to plague investors for the foreseeable future. Considering this reality, as individuals are not adequately compensated for the apparent risks within the financial system, they will increasingly look to allocate their funds to assets -- like gold -- that are unencumbered by the counterparty risks of conventional investments.
So while metals have come under pressure, realize that this is a transient phenomenon driven by a volatile and news-driven market. Yesterday and today's downward slide in precious metals is not based on a structural change in the underlying fundamentals, but is simply the result of a kneejerk response to the misinterpretation of a piece of "news." This style of volatile trading is not going anywhere; but at least it provides would-be precious metals investors with consistent dips with which to cost average into their positions.