Gold reacts to rumours, not news. This was witnessed since the onset of quantitative easing. Speculation on the consequences of expansive monetary policy contributed to a safe haven status for the metal. People went into gold to protect their wealth or hold onto the purchasing power of their money. The biggest rumour or perception though that QE created was that it would lead to rampant inflation. Such expansive monetary policy would lead to the demise of the US dollar, and one of few assets able to hold value was gold.
This theory seems to be facing some headwinds.
The rumour, belief, perception, or whatever we want to call investors take on Bernanke’s press conference following the FOMC meeting last Wednesday is that the game is over. The Fed is removing the metaphorical punchbowl from the party, and the source or backstop of liquidity for financial markets is soon to be no more. It seems to be a bit of an irony that what should be such good news prompts the kind of reaction from the markets we had Thursday of this week; however, it seems there is a lack of confidence among market participants that the real economy is able to take over from this artificial one.
To me, it raises the question as to whether the Fed actually wants to start pairing back their record bond purchases, or if they have just reached some sort of inflexion point where they are more forced to act. Perhaps the benefits of their efforts no longer exceed the consequences. As many have argued, it’s the lack of fiscal policy that has stalled the global economy over the last few years as monetary policy is an imperfect tool for correcting the market failures. Even so, it was anticipated by investors that because of the rise in yields witnessed over the last few weeks, Bernanke would seize the opportunity to try and calm markets and talk down yields. That definitely wasn’t the case as he expressed confidence in the US recovery. It is now evident that the Fed is keen on economic growth and tapering is soon to begin.
With the key focus being on the labour market, it’s the Fed’s expectation that the employment rate should fall to 7 percent by early 2014. At this point, stimulus to the markets would come to an end, and interests rates would stay low until the US economy achieves what they refer to as full employment at 6.5 percent. There is only one problem though with talks of withdrawal and raising interest rates, and that is the fact there is no inflation.
It is almost as if we have forgotten the role of a central bank. Through this extraordinary period of all different types of policy to spur economic growth, we have forgotten that one of the banks mandate is for low and stable inflation around the level of 2 percent. The lack of inflation not only slows any advancement in the labour market, but also hinders the Fed from raising interest rates without creating a hindrance to economic growth.
Many gold investors see the potential for inflation. The vast reserves created by the US Fed just sit idle in the US financial sector, but the lack of velocity or volume of that money changing hands keeps inflation levels quite tepid. This is what will keep interest rates low for the next two years, and until there is the threat or “rumour” of inflation—gold will continue to be on the defensive.