Monetary policy has long been influential in gold's fortunes. In recent times, the Fed has used bond buying and reductions to interest rates as the economy faltered. This action serves the purpose of providing more and cheaper funds for the markets to function. We have been through a sustained period of monetary easing which has resulted in the S&P 500 climbing to record highs. The Fed then decided to "normalize" rates in that it wanted to raise rates to around 6% in order to provide the wriggle room needed to offset a downturn in economic activity. A series of rate hikes was then implemented, but the Fed failed to get anywhere near its stated aim.
The Federal Reserve Reduces Rates
This week, faced with a perceived faltering economy, the Fed implemented what many thought might be the first of many rate cuts by reducing the funds rate by 25 basis points, the first since 16th December 2008. The plan for future rate cuts remains as ambiguous as ever, so the markets fell, the US dollar rose, and gold, silver and their associated stocks fell initially.
The narrative accompanying the Fed's decision included "implications of global developments for the economic outlook as well as muted inflation pressures"
The Fed cites "implications of global developments for the economic outlook as well as muted inflation pressures" in today's press conference. On the subject of future rate cuts, it said that it will "act as appropriate to sustain the expansion."
It stated that the current growth rate was "moderate" and the labor market was "strong," which is an argument for not cutting rates at all. Still it wants to get ahead of the curve in case the economy does falter. The 50-point cut that some expected didn't happen, which is what we expected as the Fed does not move fast and does not like to spring surprises on the market.
It is also watched closely by the White House as President Trump has on occasion called the central bankers "crazy" for raising rates and intimated that Jay Powell could lose his job.
The bottom line as far as we can determine is that the Fed will remain "data driven" and implement changes as and when the "data" suggests that it should do so.
The immediate reaction was that the markets fell, the US dollar jumped to higher ground, and gold prices fell. On the news of any change by the Fed, the markets tend to oscillate widely before the dust settles. However, by the end of the week, gold had made a dramatic recovery, but the markets didn't follow suit. This news still needs to be digested, but we will soon get a clearer view of the direction for all three of these entities. The only certainty we have is change, which is now inevitable.
Gold has too main enemies: the US dollar and the S&P 500. As interest rates were moving up, the US dollar gained in strength and gold stagnated due to their inverse relationship. The S&P 500 also continued to make gains, but after such a long period of expansion, those days look to be coming to an end, and so further stimuli is required if a dramatic economic correction is to be avoided.
Gold should benefit from a cheaper US dollar, but if the markets recover, then those funds will remain in the market depriving gold of the renewed interest that is so badly needed to sustain a bull market.
The central banks are actively acquiring gold as evidenced by the recent purchase made by Poland. Should this trend in demand continue, then there could soon be an imbalance between supply and demand as the explorers are not hitting home runs in terms of discovering new large deposits. As demand outstrips supply, the price will rise and in turn new players will enter this space adding to the buying pressure.
The effect of the Fed's rate reduction could be nullified as the BOJ and the ECB will follow the Fed with their own financial stimuli in order to prevent the US dollar devaluing too quickly. A devalued US dollar would present the US with a trading advantage over its trading partners which Europe and Japan can ill afford.
The markets should enjoy this rate cut, but they will be looking for more stimuli via monetary policy as this is the very oxygen that the markets need to push stocks higher.
Gold has got the message that money printing on steroids is the new paradigm, and both gold and silver will see a boost in demand, driving prices much higher.
It is early days for this gold bull, so the continuation of it in the near term will be on a "stop and start" basis, but sooner or later the precious metals will gain traction ending the misery that gold bugs have suffered over the last six years or so. The fact that gold closed the week at $1,457.50/Oz is a very positive sign in my humble opinion, and if it can stay there for a week or so, it's game on for the precious metals sector.
Ignore the white noise of the next week or so as the precious metals sector was due to correct, and there will be minor blips on the road to new all-time highs for gold, silver and their associated stocks.
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