The stir about Federal Reserve action has driven gold up to $1,740 per troy ounce, a six-month high. The SPDR Gold Shares Trust (GLD) is also at its six-month high, but the SPDR S&P 500 Index ETF (SPY) has gained much more ground over the same span. As the Federal Reserve FOMC policy statement is published this Thursday, the latest rally for both stocks and gold will come into question. When that occurs, I believe the push in gold will outdo and outlast that of stocks, because of what comes next.
The Fed almost has to act, given the level of expectations built into the system, including in both financial markets and the business environment. Of course, the Fed is not called to support stocks, but it is in its interests to protect employment and guard against inflation. In order to aid employment, it must support the economy and economic certainty, which is currently in question today.
Expectations built into the market are pretty well understood, but based on some measures, many would argue against any lift in the business mood based on Fed expectations. Certainly, consumers are not giving much attention to the Fed based on the latest measures. However, Tuesday's Small Business Optimism Index shows a measure of improvement in the mood of small businessmen in August.
In recent publishing, I've noted my view that what the Fed has to offer is analogous to a child's floatie for the management of an economic storm. As a result, after the FOMC has issued its policy, and as economic data likely continues to fail us in my view, investors will increasingly question whether the Fed is the right doctor for what ails us. Of course, the other physician is an absentee, the government, which could issue fiscal policy to treat the economy, but seems likely to be late in acting. Thus, stocks across most sectors, including the many cyclical names in the Dow Jones Industrial Average, the growth focused S&P 500 Index and the tech-heavy NASDAQ should lose their latest support. The gains in those indexes have been substantial since June, as seen here in the ETFs tracking them, the SPDR S&P 500, the SDPR Dow Jones Industrial Average (DIA) and the PowerShares QQQ (QQQ).
I think gold could continue on though, even as stocks ask for reason, because the driver will continue to be relevant. Fed actions are increasing money supply, and come as the ECB is planning a sterile stimulus in which it will keep the money supply stable as it provides support to euro area bonds. Thus, the dollar, despite today's confidence in it, is comparatively weakened. As the fiscal cliff approaches, I believe the dollar will come under more question, as evidenced by Tuesday's statement by Moody's (MCO), warning of a downgrade of U.S. credit. The warning sent the dollar lower Tuesday, as seen in the near one point increase in the PowerShares DB US Dollar Index Bearish (UDN).
These things support gold as a currency option against the dollar and other paper money. Gold miners should likewise garner support, as confidence increases for longer term higher gold pricing. Investors seeking an interest in the gold miners might use the Market Vectors Gold Miners ETF (GDX), rather than investing in individual names like Goldcorp (GG) or Newmont Mining (NEM), if not familiar with company specifics.
In conclusion, my thesis gives reason to continue investment in gold and gold relatives, while cutting exposure to stocks gradually over the next several weeks. I continue to believe the Federal Reserve will act in favor of stimulus, and I see stocks maintaining strength at least through Thursday. However, Friday offers a key test, with several important economic reports due. In my view, gold does well as long as the Fed acts, and despite economic deterioration, so go the way of gold instead of stocks. I would buy the metal, the GLD and the GDX for the long-term, despite their latest highs; I hold the metal. I would start gradually trimming stock and index ETF holdings, including in the SPY, DIA and QQQ.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.