The Federal Reserve Did It Again to Gold Prices
Source: Eric McWhinnie, Wall St. Cheat Sheet (4/4/12)
"Once again, the markets made large moves based on the Fed's word of mouth, this time to the downside."
On Tuesday afternoon, the Federal Reserve board and the Federal Open Market Committee released the minutes of the committee meeting in March. The Fed said it sees no need to add more easing unless growth slows. The statement explained, "A couple of members indicated that the initiation of additional stimulus could become necessary if the economy lost momentum or if inflation seemed likely to remain below its mandate-consistent rate of 2% over the medium run." Once again, the markets made large moves based on the Fed's word of mouth, this time to the downside.
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Since the Fed minutes, gold has declined from almost $1,680 to $1,615/ounce (oz). Meanwhile, silver prices have dropped from $33.20 to $31.05/oz. The dramatic pullback is reminiscent of the Leap Day massacre that occurred in precious metals earlier this year. On February's extra trading day, gold and silver dropped $77 and $2.56/oz, respectively. The massive sell volume came as Bernanke offered no new stimulus in the Fed's semiannual Monetary Policy Report to Congress. However, the fact remains that the Fed and other central banks around the globe remain ready to offer more stimulus to the economy when growth and inflation slow.
The Fed's own minutes even recognized the global race to debase currencies: "Several other central banks in advanced and emerging market economies eased policy further. In particular, the Bank of England increased the size of its existing gilt purchase program in February, and the Bank of Japan scaled up its Asset Purchase Program. The Bank of Japan also introduced a 1% inflation goal." Earlier today, Mario Draghi, president of the European Central Bank, said that any discussion of an "exit strategy" in terms of monetary policy is premature. Draghi went on to say that inflation in the euro area is likely to remain above 2" this year, but should decrease below the level next year. Inflation in the Eurozone decreased to 2.6% in March, compared to 2.7% in February.
Although the Fed statements may seem confusing, it is hard to imagine the central bank stepping aside from purchasing bonds and propping up the economy. Last year, the Fed purchased 61% of the total net Treasury issuance, according to the Wall Street Journal. Furthermore, Barclays estimates that under Operation Twist, the Fed purchased 91% of all gross issuance in long-dated U.S. Treasuries. With commodity prices at elevated levels, central banks are simply in a holding pattern and must talk down prices before any more easing is officially announced.
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Eric McWhinnie, Wall St. Cheat Sheet
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Disclosure: Long EXK, AG, HL, PHYS