Why Buy Gold On Fed Catalyst

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 |  Includes: AUY, EGO, GDX, GG, GLD, IAG, KGC, NEM, UDN, UUP
by: Markos Kaminis

The Federal Reserve's FOMC balk set several things in motion Wednesday, including gold prices lower. The SPDR Gold Shares (GLD) dove sharply when no new quantitative easing or other creative measure was announced by the Fed. Spot gold had still not recovered in overseas trading at the hour of scribbling here ($1600.30 USD/oz. at 9:12 AM EDT), but I'm confident it will. Here's why…

Chart forSPDR Gold Shares

Gold declined because the Fed fuddled in its August opportunity to take new monetary action. The reason gold reacts this way is not obvious for the casual follower, but Fed efforts to drive economic expansion have involved dollar dilutive side effects. The Fed has outright cut key bank rates to bottom dollar levels. In doing so, it seeks to draw dollars into use through increased spending, borrowing and lending. Also, it is driving down mortgage rates and other rates through its asset purchases. It creates a sort of synthetic demand, and so yields decline, which is supportive of economic growth. Mortgage rates are at record lows, partly as a result of these efforts and partly because the market for real estate remains stuck in place due to dynamic factors. FYI, I think it's time to buy real estate now.

When the Fed buys, it uses dollars to do so and increases the money supply. Since gold is priced in dollars, its value changes in relation to the relative value of the diluted dollar. Illustrating: The PowerShares DB US Dollar Index Bullish (UUP) reflects changes in the dollar against other currencies; it rose 0.7% Wednesday as the GLD declined 0.86% and the PowerShares DB US Dollar Index Bearish (UDN) fell 0.65%. There are two reasons why gold is negatively correlated to the dollar. First, because it is a hard asset in demand, and second, because it is humankind's inherent currency, in my view and the view of many others. Therefore, it's a fallback currency in times when the dollar loses demand.

Many companies have highly correlated revenues and earnings to the price of the commodities they produce, or refine and sell. For instance, Wednesday, like gold, the shares of gold miners declined.

Company & Ticker

Tuesday % Change

SPDR Gold Shares

-0.86%

Market Vectors Gold Miners ETF (GDX)

-1.35%

Goldcorp (GG)

-1.4%

Newmont Mining (NEM)

-0.1%

Kinross Gold (KGC)

-4.5%

Yamana Gold (AUY)

-0.6%

IAMGOLD (IAG)

-3.1%

Eldorado Gold (EGO)

-1.5%

Click to enlarge

I feel confident that the Federal Reserve along with the European Central Bank and other central banks around the world will continue to use monetary policy to stimulate their relative economies. As a result, I continue to believe they will increasingly turn to gold as a reserve currency. It is hard to manipulate directly, though is limited in supply and is humankind's fallback currency. Therefore, on days like Wednesday and today, when gold prices soften, I suggest the continued purchase of the commodity and relative investments mentioned here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.