LAWRIE WILLIAMS: Gold: Pause, setback and waiting on the Fed
We had intimated in previous posts that gold’s seemingly recent upward price movement would find the $1,900 psychological level more difficult to crack than the $1,700 and $1,800 levels on the way there, but the strength of the resistance has been greater than we anticipated. Yesterday the price collapsed into the $1,840s before making a partial recovery, but still only ended the day in the mid $1,860s – way below the plus $1,900 spot price levels seen earlier. It has been fairly weak again today in early European trade,
The reason for our earliercaution was that we judged that the upwards price momentum we had been seeing throughout May appeared to be wavering. The markets were looking ahead to the deliberations at this week’s FOMC meeting before taking any decisions as to where the price was likely to be headed at the height of the northern summer holiday season, which is now just about upon us. We did comment that the gold price would be data driven, and this proved to be the case with what we saw as an over-reaction to the ADP private sector employment figures which came in far higher than market analysts had been anticipating.
Subsequent events initially followed much as we had predicted,, but perhaps in an over-exaggerated manner. Precious metals prices indeed fell too far too fast and made a pretty rapid recovery. But since then they have been much more volatile than we might have forecast, dependent on views on U.S. inflation and whether the Fed will, or will not take defensive measures because inflation might be seen as getting out of control. We think, though that the Fed will hold firm and not change its ultra low interest rate policy until U.S. unemployment falls back to pre-pandemic levels which may well not be until mid-2022, or later. Ultra low rates coupled with climbing inflation, is strongly gold positive as it means gold is even more competitive with bonds and fixed interest options in the resultant effective negative real interest rate environment.
There were also positive PMI data released last week, and the dollar index gained as well, so markets seemed to be breathing a sigh of relief that the U.S. might be recovering from the virus pandemic more rapidly that had previously been envisaged. Nevertheless the major stock indexes were somewhat mixed in their reactions. Perhaps the ever–continuing equity valuation growth we have been seeing over the past couple of years – unjustified by performance economics in our opinion – might at long last be hitting the pause button. Maybe the market crash we have been forecasting is still receding in likelihood, but we do see some kind of correction as inevitable as the world comes out of its Covid-related recession.
In the U.S. – the key global market driver - Fed policy should become a little clearer after the FOMC meeting, but we suspect that although a possible tapering initiative will come under discussion, the U.S. central bank will hold firm on its current interest rate and QE programmes. Given that it has been undershooting its average inflation target for so long, it has the wiggle room to encompass – perhaps even encourage – higher inflation rates for a few months to bring the average back on track.
However, the very fact that inflation may be talked about by the meeting participants could itself move markets.. Anything suggestive that the Fed may bring its current easy money policy under consideration ahead of its stated timescale, however remote, will be seized on by the markets and perhaps lead to a small reversal in equity prices and positive moves marginally upwards in gold and silver. Whether this will create enough momentum to bring gold permanently back above $1,900 and silver maintaining a $28 plus price level is a little less certain, but one can rest assured that the potential for rising inflation, and possible Fed moves to combat it, will remain a subject of strong interest to the media and the markets.
Past gold and silver performance when gold has initially stalled around prior ‘psychological’ levels suggests that the $1,900 permanent breach will occur sooner rather than later. We could yet be in for summer fireworks in gold and silver - but watch out for the July 4th holiday period and then Labor Day at the beginning of September. Major U.S. holidays often seem to precipitate inflection points in precious metals pricing.
The Fed will look at the latest positive U.S. employment data and draw the conclusion that its current ultra-low interest rate level plus a significant bond and mortgage security buying programme is working out as it has predicted. Restoring employment it sees as its primary aim and given that it will probably see its current programme as working well, it will probably continue on the same track, ignoring possible inflation rate rises, In any case it does see itself as having short term solutions should it feel the inflation rate may be getting out of control- and its nowhere near that level yet.
In other words, we see the current easing and ultra-low interest rate programme as likely continuing, perhaps well into next year- or as long as it takes to achieve its aim of around 3.5% unemployment. As long as real interest rates stay roughly where they are this will remain positive for gold and silver, which we see as resuming their upwards paths before too long. Increased real inflation will provide an additional bonus for precious metals which would further advance our positive prognosis.