Last Wednesday afternoon, after the FOMC announcement, the price of gold (in dollars) went up. On Thursday gold ETF GLD (GLD) closed at its highest level since February 25th. But what actually happened? The FOMC announced that it would begin buying U.S. treasuries on the open market, this at the same time that U.S. treasury auctions are tripling and quadrupling their bond sales in order to pay for the massive increase in the U.S. budget deficit.
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In the above chart, the dollar price of gold is represented by GLD and the dollar indexed against a basket of foreign currencies is represented by dollar index fund UUP (UUP). Before the FOMC announcement Wednesday afternoon, we can see that the dollar was holding steady down about 1% from the previous day, and the price of gold dropped by 3% to 4% with no apparent explanation.
This smacks of manipulation (shorting gold futures) by insiders who wanted to keep the gold price under control and prevent it from popping over $1000 when the Fed made its announcement later in the day. By the close of trading Thursday, the dollar had lost about 4% of its value against a basket of major foreign currencies since the preceding day’s FOMC announcement; a huge, almost unprecedented one day drop. Foreign holders of U.S. long bonds lost 4% in a single day on an investment which yields only about 3% annually.
At the very same moment, gold prices spiked, closing Thursday about 7% higher than where gold was trading at the time of the announcement. Of that increase, 4% was due to the immediate decline of the dollar index, and the other 3% most likely was due to hedging against the expected inflation which the Fed’s action would cause.
Friday and Monday the dollar and gold price were basically flat, until late Monday afternoon we see the price of gold declined a bit. In the last hour of trading on Monday, there was a huge volume of equity buying across the board in a massive wave of irrational exuberance, especially in the financial and real estate sectors. Apparently many people took profits in GLD at this time, liquidating shares to use the money to invest in their favorite equities.
This spike in buying near the close of trading Monday also smacked of manipulation, as the PPT wanted to create the appearance of widespread acceptance of Geithner’s plan to enlist private hedge funds to buy so called “toxic” assets from the banks, at the taxpayer’s risk. This knee jerk reaction was before these buyers had time to read the fine print. The hedge funds will be given cheap loans of taxpayer money for at least 94% of the purchase price of these assets, and risk only a maximum of 6% of their own money. So the taxpayer takes 94% of the risk, and gets to share 50% of any future profits.
Once this information is digested, Monday’s stock rally will undoubtedly be reversed.
Calling these assets “toxic” is a scare tactic used by the banks to get more taxpayer money. They repeatedly claim that there is no way to value these assets.
In reality, there is one sure way to value these assets. Let the market do it. There are plenty of buyers for these mortgage backed securities and CDO’s, even the subprime and alt-A variety, at the right price. If the banks had put them on the market a year ago, they would have gotten a lot more for them than they could today, but they are hoping against hope for an economic recovery or taxpayer bailouts to pay for their recklessness and poor investing skills. And if they were to reveal the details of their true holdings, it would be an admission of insolvency, and the huge amount of continuing financial support which would be necessary from taxpayer bailouts to keep banks afloat that should have been put into receivership in the first place.
So why would the Fed be buying treasury bonds on the open market at this point in time? Wouldn’t it be more logical to just sell less bonds in the government auctions rather than be buying and selling treasury bonds simultaneously?
Treasury bonds are really just IOU’s of the federal government. When they are sold to finance the government’s deficit spending, they take money out of circulation, which is bad for the economy at a time when it needs that money to stimulate economic activity. By buying treasury bonds on the open market, (also known by the euphemisms “monetization of debt” and “quantitative easing”), they increase the supply of money and replace some of the money they have just removed from circulation in the bond sales which could hamper the recovery.
So why all this smoke and mirrors of adding and removing money from circulation at the same time? Apparently to make it look like we are selling enough treasuries to cover our new unprecedented levels of deficit spending.
So did the price of gold actually go up? Only in US dollars. What really happened? The value of the dollar went down, and the price of gold worldwide remained basically unchanged.
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So over the five day period from Tuesday’s open to Monday’s close, the above chart shows that the dollar had lost about 4% of its value and gold and long treasury bonds (as represented by treasury bond index TLT) (TLT), had gained about 2% in value. Since both prices are denominated in dollars, we would expect to see a corresponding 4% increase in the value of gold and treasuries, so in real terms, they both declined by 2%.
Why would treasuries decline in real value by 2% in response to the announcement that the federal government would be buying $300 billion worth over the next six months? This added demand would be expected to cause an increase in value, above and beyond the 4% decline in the dollar’s value. The answer seems to be that the bond market recognizes that the overall supply of treasuries will be increasing drastically, and this government buying of its own debt is all smoke and mirrors, an act of desperation.
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The chart above shows that gold held its value against the Australian dollar, the British pound, the Canadian dollar, the Euro, and the Swiss Franc (as represented by currency ETFs Australian dollar ETF (FXA), British Sterling ETF (FXB), Canadian dollar (FXC), Euro (FXE), and Swiss Franc (FXF) for days after the Fed announcement, until the last hour of trading during Monday’s buying spree on the US equity markets. It also highlights the mysterious decline in gold price in early Wednesday trading before the Fed announcement, as denoted by the dumping of GLD.
Disclosure: No positions