GLD - How The Fed Plays

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Includes: DGL, DGLD, DGP, DGZ, DZZ, GEUR, GHE, GHS, GLD, GLDI, GLDW, GLL, GTU, GYEN, IAU, OUNZ, PHYS, QGLDX, SGOL, UBG, UGL, UGLD
by: Markos Kaminis

Summary

The SPDR Gold Trust gained immediately after the Fed meeting minutes release.

The minutes sounded a dovish tone.

Gold investors are not buying into an argument for easing inflation, but are celebrating a possibility for a slower pace of Fed Funds Rate hikes.

Though I expect May economic data coming in June to revive concern ahead of the meeting in June.

Other factors also weigh in favor for gold.

Judging by the immediate reaction of the SPDR Gold Trust (NYSE: GLD) after the 2:00 PM EDT release of the FOMC meeting minutes Wednesday, it appears the Fed is priced into gold at this point. After thorough review of the minutes, I interpreted a somewhat more dovish tone than expected, which benefits the GLD, a widely held proxy for gold, for now anyway. I expect data to heal in June and for Fed fear to renew ahead of the meeting, though other factors also weigh for gold. Let's review the Fed meeting minutes together here for a look at how the interest rate and inflation outlook might weigh for the security.

The SPDR Gold Trust is a widely held proxy for the price of gold and moves hand in hand with gold. It had a surprisingly good day Wednesday after the 2:00 PM release of the Fed meeting minutes. I say surprising because all things Fed these days tend to work against gold, given the Fed's monetary tightening trajectory. Also surprising was that gold and stocks moved together in the right direction.

I picked through the FOMC's May meeting minutes for you for tidbits that I believe matter most for gold.

First, let us note that there was no major change in tone from the Fed, which I believe was evidenced by this statement from the minutes:

They continued to expect that, with further gradual adjustments in the stance of monetary policy, economic activity would expand at a moderate pace, labor market conditions would strengthen somewhat further, and inflation would stabilize around 2 percent over the medium term.

A dovish tone is not generally expected from the Fed these days; rather, we expect to see gradual tightening with appeasing statements about the still accommodative state of monetary policy set in place to ensure market stability as the Fed normalizes its policy. It's necessary because of the so far tepid pace of economic recovery and shy pace of inflation. Should either of those two circumstances change, then the market would actually prefer a more aggressive conversation from the Fed to keep inflation and fears of it in check.

While I have recently expressed concern about a forward heating of inflation that apparently some Fed members also worry about, the Fed's notes mention recently softer data with regard to inflation and also economic growth. This also serves gold if the market does not buy into the idea that inflation is easing, because the market would then focus on a reduced likelihood of tightening actions and pace of such actions. Here's what we read from the Fed:

Regarding the outlook for inflation, a couple of participants expressed concern that a substantial undershooting of the longer-run normal rate of unemployment could pose an appreciable upside risk to inflation. However, several others continued to see downside risks to the inflation outlook, particularly given the low readings on inflation over the intermeeting period and the still-low measures of inflation compensation and inflation expectations. Participants agreed that the Committee should continue to closely monitor inflation indicators and global economic and financial developments.

Let's note the Fed's focus on data, implying that May's economic data (reported in June) could significantly influence what the Fed does in June, as expected. Given that more recent data has been soft, the market wants to see a reduced chance of Fed action in June. I, however, do expect economic data, including price data, to show up better for May than it did for April. I believe as we move forward in the weeks ahead, such data will harm the price of gold somewhat. Though, I believe such harm could be temporary if the Fed adjusts its inflation and Fed Funds Rate forecasts higher in June as a result of hotter data for May. That is what I expect to happen, if not in June, then in September or soon enough.

With regard to economic growth, which was reported slower in the first quarter, it seems the Fed agrees with my notation about recent years' patterns. Over the past couple years, we've seen slow first quarters followed by strong second quarters. In other words, it's transitory or seasonal at this point.

While recent data suggested a significant slowdown of growth in consumption spending early in the year, participants expected to see a rebound in consumer spending in coming months in light of the solid fundamentals underpinning household spending, including ongoing job gains, rising household income and wealth, improved household balance sheets, and buoyant consumer sentiment. It was noted that much of the recent slowing likely reflected transitory factors, such as low consumer spending for energy services induced by an unusually mild winter and a decline in motor vehicle sales from an unsustainably high fourth-quarter pace.

The Fed's better expectations for the economy does not serve the GLD well, as it raises the likelihood of monetary tightening and a stronger dollar, for as long as inflation is in check. The stock market was likely also enthused to hear how the Fed felt about business spending and the contribution of an improving global environment.

Several participants noted that surveys of business conditions in their Districts continued to indicate expanding activity. A few participants commented that firms engaged in international trade were benefiting from improvements in global demand conditions.

My concern for inflation is, however, exemplified by this statement. I believe labor market conditions will serve wage inflation, and help drive overall price increase.

Labor market conditions in many Districts were reported to have continued to improve. Contacts in several Districts reported a pickup in wage increases, shortages of workers in selected occupations, or pressures to train workers for hard-to-fill jobs.

Core PCE price inflation, which historically has been a good predictor of future headline inflation, moved down to 1.6 percent over the 12 months ending in March. However, it was noted that some of this slowing reflected idiosyncratic factors such as a large drop in the measure of quality-adjusted prices for wireless telephone services. Several participants emphasized that inflation measured on a 12-month basis had been running very close to the Committee's 2 percent target. Overall, most participants viewed the recent softer inflation data as primarily reflecting transitory factors, but a few expressed concern that progress toward the Committee's objective may have slowed. Market-based measures of longer-term inflation compensation remained low, with five-year, five-year-forward CPI inflation compensation a bit below 2 percent--unchanged from the time of the March FOMC meeting but somewhat above levels registered last year. In addition, the median measure of inflation expectations over the next 5 to 10 years in the Michigan survey edged down from 2.5 percent in February to 2.4 percent in March and April. The three-year-ahead measure of inflation expectations from the Federal Reserve Bank of New York's Survey of Consumer Expectations decreased from 3.0 percent to 2.7 percent in March and rose to 2.9 percent in April.

In light of these developments, participants generally continued to expect that inflation would stabilize around the Committee's 2 percent objective over the medium run as the effects of transitory factors waned and conditions in the labor market and the overall economy improved further.

In their discussion of recent developments in financial markets, some participants commented on changes in financial conditions in the wake of the Committee's decision to increase the target range for the federal funds rate in March. They noted variously that the decline in longer-term interest rates and the modest depreciation of the dollar over the intermeeting period would provide some stimulus to aggregate demand, that the Committee's recent policy actions had not resulted in a tightening of financial conditions, or that some of the decline in longer-term yields reflected investors' perceptions of diminished odds of significant fiscal stimulus and an increase in some geopolitical and foreign political risks.

In their consideration of monetary policy, participants judged that it was appropriate to leave the target range for the federal funds rate unchanged at this meeting. Although the data on aggregate spending and inflation received over the intermeeting period were, on balance, weaker than participants expected, they generally saw the outlook for the economy and inflation as little changed and judged that a continued gradual removal of monetary policy accommodation remained appropriate... Most participants judged that if economic information came in about in line with their expectations, it would soon be appropriate for the Committee to take another step in removing some policy accommodation.

While this statement leaves the likelihood of a June Fed action in place, it serves to sooth concerns about many more rate actions this year, which serves the GLD if the prospective June action is already priced in. The following statement also reinforces that likelihood.

Participants generally reiterated their support for a continued gradual approach to raising the federal funds rate. Some participants noted that core PCE price inflation had been running below the Committee's objective for overall inflation for the past eight years and that it was important to return inflation to 2 percent, or that the public's longer-term inflation expectations may have fallen somewhat, and that a gradual approach to tightening could help return expectations and inflation to 2 percent.

Several participants, however, pointed to conditions under which the Committee might need to consider a somewhat more rapid removal of monetary accommodation--for instance, if the unemployment rate fell appreciably further than currently projected, if wages increased more rapidly than expected, or if highly stimulative fiscal policy changes were to be enacted. In contrast, a couple of others judged that the Committee could withdraw monetary accommodation even more gradually than reflected in the medians of forecasts in the March Summary of Economic Projections, noting that slack might remain in the labor market or that inflation was not very sensitive to declines in the unemployment rate below its estimated longer-run normal level.

On net, confusion within the Fed about the current state of affairs serves gold as well, considering that the main message has been one toward tightening. On balance, it appears that expectations for rates have come down for the balance of the year no matter what happens in June. That is a positive for the SPDR Gold Trust, since it has likely already priced in a June action. The Fed minutes, however, were dovish enough to leave even a June action uncertain if data reported in June for May shows continued softness. In conclusion, I expect gold to continue to benefit until fresh data changes the message, which I do expect to happen in June. However, other factors also weigh for gold today, including uncertainty about the leadership of America and also a shift to a more aggressive foreign policy.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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