Friday, January 17, 2014

Fed Taper a Golden (XAU) Move

Gold may have put in an important low on December 31st, trading to $1182.57, just above the June 28th low of $1180.57.  Interestingly, those lows are separated by exactly half a year.  Back in June the Fed had started to indicate an interest in beginning the tapering of its securities purchase program. In December, the Fed finally followed through on that ‘commitment’ and announced a start of that reduction to begin in January.

Many have raised concerns over the last 5 years that Fed securities purchases risked stoking inflation.  As time has passed, these cries have become less outspoken as mainstream has come to regard such notions as somewhat archaic and of a distant era.  However, I suspect others may regard the application of easy monetary policy in an effort to reverse recessions birthed of financial excess as a very inexact science.  As such, it has been my premise since before the first application of unconventional monetary policy measures, that these efforts would eventually overreach and live too long-that the Fed would do too much and do it too late.

Year after year since 2008, Fed projections for economic growth had overestimated that eventually seen.  Conditioned by these target misses, we can understand how Fed officials might eventually succumb to lacked confidence in abilities to provide enough stimulus to support economic traction.  Eventually, despite continued signs of stable growth, Fed officials were destined to underestimate the support they were providing.

The Fed having decided to ‘tighten the spigot’ by reducing the level of additional accommodation provided in lesser amounts of monthly purchases, has for some further reduced concerns for a break-out in inflation.  However, if because the Fed had been slow to adjust policy enough to properly support economic growth for so many years and have thus finally moved to a position of having over-reacting,  we should expect the seeds of inflation have been firmly planted and watered and in time we shall see the fruit. 

There is little concern for inflation today and maybe rightly so.  The output-gap is seen as only slowly closing and wage inflation is only spotted in a few ‘higher-skilled’ job classes.  However, to the extent the output-gap may be smaller than believed and to the extent ‘higher-skilled’ jobs represent a greater portion of our economy that previously believed, inflation may increase faster than many now can imagine. 

As such, I am of the mind that the best time to own inflation protection is as the Fed has recognized they have likely done enough to stimulate the economy, because they have instead likely done too much.  Gold back in June of 2004 was under $400, but as the Fed proceeded to ‘normalize’ monetary policy from having reduced the policy rate to a multi-decade low of 1%, Gold rocketed to $730 before they had completed their ‘measured pace’ policy rate hikes.  

Today gold is under $1250 having seen nearly $2000 in late-2011.  Some traders talk of higher carry costs as short-term interest rates are projected to rise as soon as 2015, by some trader’s belief.  However, I suspect that if I have been correct in expecting the Fed to eventually over-react and add too much liquidity too late and if the Fed is at all consistent with prior efforts toward ‘normalizing’ policy, we should expect the groundwork has been laid for well higher gold prices that will not be appreciably influenced by slightly higher carry costs. 

Technically, see the December 31st session as a ‘high-wave’ test of the 3 year low.  The low held and price action has since firmed slightly.  A downward sloping trend line dating from Oct 30 was bested on the second day of this year.  Finally, the ‘mid’ of the bullish advance last Friday (Jan 10) held against a test over the subsequent 3 sessions.  No attention has been given to the slight advance and little should be expected until $1300 at a minimum has been breached.


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