Precious Points: Its A Hit!
The path of least resistance continues for the moment to be upward... With financial markets undoubtedly improving, stocks performing reasonably well, and gold and oil at soaring, some of the impetus for a 50 bps cut may have been removed. Though a rate cut should theoretically boost precious metals, the markets seem to already be priced for 25 bps cut and, if this is all they're given, could choose to sell the news... Use [5-week sma] to see past the short term wiggles and attach a direction to the larger trend, whether we are beginning a dramatic selloff that will entirely erase the year's gains, or if this is yet another consolidation before $800 and beyond. That way we'll know for sure as the days and weeks remaining in 2007 unfold, when the mighty B.B. steps to the plate, whether or not he's struck out. ~ Precious Points: The Mighty B.B., October 27, 2007
There's always plenty of speculation ahead of a Fed meeting, and the Halloween hoopla was no different. There's always a head-fake reaction after the statement, and the Halloween juke was no different. What was a little unique this time was the almost universal consensus, after strong GDP and tame inflation data, the Fed would cut 25 bps - it was the market's response that was largely up for grabs. And, as mentioned in the TTC forums, this time around it would be the statement that had more influence than the action itself.
So, last week's update offered a simple game plan: don't be surprised by an initial sell-the-news reaction to a quarter-point cut, but don't call it a reversal if the 5-week moving average remains intact. As you can see from the chart below, gold did take an initial hit on the cut, but never seriously threatened our critical level.
Anyone who dug in and stayed long those few minutes were rewarded for their patience by an extension above $800 in the days that followed. Those who added to their positions, even more so.
It was a similar story in silver, where the 5-day moving average was tested and held just after the Fed. Ultimately silver would retest the psychologically significant $14 level, reprising it's perennial role as gold's more volatile and less monetized understudy, but managed a convincing close above $14.50
As much as some market participants may have wanted it, last week's update explained why a 50 basis point cut had become unlikely, and that only impending economic disaster could possibly motivate so deep a cut in the face of record gold and oil prices and buoyant stocks. But, presumably, even with a .25 point cut, the balance of risk could have remained tilted towards preventing fallout from impending housing foreclosures, and this would have been consistent with Bernanke's remarks of a few weeks before. That the Fed chose to explicitly cite high energy and commodity costs not only undermines their precious core inflation figure - which now seems to exist only for justifying low interest rates and creating implausible GDP growth figures - it also underscores a long-standing theme of this newsletter, namely that rising metals prices are anathema to a central bank because they tend to erode the credibility of fractional reserve lending and fiat currency.
But, sometimes those in positions of authority simply have no good options and, when given the choice of igniting a parabolic rise in gold and oil or carefully acknowledging that its core inflation readings are fairly irrelevant to real world consumers, and are ultimately affected by the excluded items anyway, the Fed, it seems, takes the latter course. And whenever power makes hard choices, it's axiomatic that the alternative was even worse! Recall the following passage from the October 13 update:
"With at least one presidential candidate calling for the outright dismantling of the Federal Reserve System, the role of Federal Reserve chairman will not be easy and Bernanke is probably wise to remain the humble academic. And as his fate and that of his institution unfolds, the dollar price of precious metals will be a key factor in shaping public perception and political exigency."
So there was some curious choices of language in the statement that deserve attention, but, despite the headlines, nothing that precludes further cuts, meaning Thursday and Friday's decline in stocks had more to do with uncertainty in the financial sector and calendar positioning by funds as it did with the Fed's supposed pause signal. In all likelihood the FOMC would lower rates again if further calamity befell financial markets or the larger economy, but in the near term at least, the Fed's goal seems to have been to talk up the dollar and talk down commodities. And only so far have they failed. If I didn't know better I'd say it appeared there was a battle being waged between anti-inflationary forces with the Fed in one camp, and broker/banker forces allied with major media attempting to force another cut on the other. Of course, this is not to be accusatory, only precautionary!
As mentioned last week, a decline in gold to back below $600 is almost becoming unimaginable, but at the same time, the rapid ascent in the yellow metal is starting to be reminiscent of early 2006. Starting to be. Fundamentals would have precious metals rise steadily in value over a long period of time, but short term volatility in gold and silver as we've recently seen is created not as much by fundamentals as by rapid money that can flow out just as quickly as in. Or quicker. In other words, gold frequently flirts with its 5-week moving average and a situation where it is $25 or more beyond this level is probably unsustainable, though this does not necessarily require anything more than consolidation.
But then there's the dollar. Despite official rhetoric, the U.S. seems to have embraced a weak dollar policy - and afterall, why not? A cheap dollar helps finance massive deficit spending and gives the appearance of closing trade imbalances. Still, as unsubstantiated as it may yet be, the idea that a rate cut could actually rally the greenback is based on the idea that cheaper money would bolster the economy. Though of flimsy credibility at best, recent economic data has tended to reflect the Fed's optimistic outlook and its accommodative stance at the same time the U.K. and Europe have begun to seriously address the gravity of their financial situations. Doubts about the global growth story have already contributed to weakness in silver, and, if any of the major western central banks begin to sound dovish, it might be nothing more than currency arbitrage that lifts the dollar off its lows for a time and gives the precious metals rally a breather.
However, as mentioned, recent weakness in stocks has been more closely related to the tape bombs in the financial sector than any other single factor and, as this cornerstone of the market founders, money thus flocks to precious metals and other assets of sound, reliable, intrinsic value. Over the course of the next year, foreclosure rates will hit their peak, further eroding the value of mortgage-backed securities and the books of their owners, and likely obliging the Fed to take further loosening action. Nothing in their October 31 statement contradicts that assessment. To the extent markets realize this likelihood, intermediate targets in gold now range up to $845, and $15.80 in silver.
In the meantime, though, powerful interests will probably continue seeking to reign in the precious metals rally, and polishing up appearances in the financial sector could be one particularly effective way for this to be accomplished. And, in the interest of sustainable gains, perhaps a little retesting might be in order anyway. At least the $800 level, to check for a possible floor there. Besides, after the recent rallies, as unlikely as it is, and disastrous as it would seem, a decline to $675 in gold would only be a retest of the 50-week sma and no threat to the long term bull market!