Fed Tightening and the Gold Market

In the last post, I posed the question "Safe to dip in the gold pool again?" as the Amex Gold BUGS Index (HUI) was on the verge of breaking out of a down trend. The answer since has been an emphatic "No". Despite the awful employment number last Friday the expectation for Fed tightening has never been higher. Although I have been quite dismissive of the jawboning, a convincing case for tightening can be made on the following:

1. The primary argument against tightening has been the weak economy which has entered the political center stage in this election year. However, one may well argue that energy and food inflation brings an economic pain as pressing as any to the middle class. Therefore, there is plenty of political cover for tightening.
2. As far as the credit crisis is concerned, the alphabet soup of new credit facilities are more powerful and precise than the blunt instrument of the Fed funds rate.
3. Perhaps more importantly, the bond market has spoken, and the expectation is definitely higher rates by October.

The dollar has been gaining strength on the back of all this talk of Fed hiking the rates. The energy complex has stayed firm because of the fundamental supply/demand. On the other hand, gold, which has been regarded as a pure dollar play, has been crushed. The mining stocks have been falling alongside the metal. The HUI, at 397 on Thursday, is now below the 200-daily moving average [dma], and poised to test the April low of 385.

From an Elliott Wave [EW] perspective, the most logical count has us in wave c of an abc correction where wave a bottomed at 385 (I thought it was the end of the correction then but that count was invalidated as the low in early May was taken out). I'm now expecting more weakness in the near term until the relative HUI (HUI/its 200 dma) becomes as attractive as say last August which would be another excellent entry point.

click to enlarge

How do I reconcile Fed tightening/dollar strength with a long term bull market in gold? The simple answer is that I remain skeptical of new found hawkishness at the Fed. October is months away, and I'll believe in those rate hikes when I see them. In the meantime, I'll be more wary of administrative measures at containing commodity prices such as releasing oil from the Strategic Petroleum Reserve or limits on the so-called commodity index funds.

Comments

[dieuwer:]

Tightening to what interest rate level? 3%? What a joke!
In the 70's, interest rates had to go to 15+% to derail the gold bull. Long way from that now...

2008 Jun 13 09:42 AM

[jetsby10:]

People on Wall St claimed the fed was Hawkish when they cut by "only .75". These people need to take a logic class.

2008 Jun 13 12:58 PM

[Hugh:]

The Fed will most likely cut. Any good news on the economy will be flash in the pan. The Fed sees a weak dollar as a way to inflate out of the huge debt overload. They are praying for wage inflation. Getting the average household income to $200,000 would make milk $40 a gallon, but look how easy is would be for Mr. Smith to make his house payments if flipping hamburgers paid $50 per hour...

2008 Jun 13 01:48 PM

[sammyg123:]

Higher interest rates make gold less attractive. The end.

2008 Jun 14 06:40 PM

[Golden Oxen:]

All fiat currencies have always lost their value against gold over all of recorded history. This interest rate babble is meant to confuse and contribute to the prolonging of the current counterfeit scheme. Gold has no yield because it is real honest money.

2008 Jun 15 01:59 AM