Mar­ket sen­ti­ment for Gold af­ter the Fed’s de­ci­sion for a rate hike de­lay

Financial Mirror (Cyprus) - - FRONT PAGE -

Traders and in­vestors are of­ten in two minds about pre­cious met­als, no­tably gold. Now that the re­cent Fed­eral Re­serve de­ci­sion has been an­nounced and an in­ter­est rate hike is off the cards, a lit­tle un­cer­tainty has per­vaded the gold mar­ket. When the Septem­ber de­ci­sion of the Fed FOMC was made, the state­ment re­leased by the author­i­ties ex­plained why a rate hike was disin­gen­u­ous at the time. Emerg­ing mar­ket weak­ness, de­clin­ing de­mand in China and the coun­sel of the In­ter­na­tional Mone­tary Fund (IMF) all cau­tioned against hik­ing in­ter­est rates at the time.

De­spite this, Janet Yellen al­luded to the pos­si­bil­ity of a rate hike be­fore the end of 2015. Fast for­ward to the Oc­to­ber FOMC de­ci­sion; the same de­ci­sion was reached but with one im­por­tant dif­fer­ence. The Fed state­ment made no ref­er­ence to global eco­nomic weak­ness. This im­plies sev­eral things, no­tably: the Fed is likely to move swiftly to in­crease in­ter­est rates be­fore the end of the year at the De­cem­ber 15/16 meet­ing, and the Fed is less con­cerned about the po­ten­tial im­pact on the US econ­omy vis-a-vis China and emerg­ing mar­ket economies when it comes to hik­ing in­ter­est rates.

Typ­i­cally, a de­ci­sion not to hike in­ter­est rates would be per­ceived pos­i­tively by gold traders. Since gold has no abil­ity what­so­ever to earn in­ter­est, it loses its ap­peal as the go-to financial as­set dur­ing times of ris­ing in­ter­est rates. In other words there is more to be gained by in­vest­ing money in Trea­sury notes, bonds, CDs and other in­ter­est-bear­ing funds. Eq­uity mar­kets tend to move in an in­verse re­la­tion­ship to in­ter­est rates since ris­ing in­ter­est rates im­ply ris­ing costs on long-term debt for com­pa­nies. This ul­ti­mately leads to a de­crease in over­all prof­itabil­ity, div­i­dends and share prices. There is the like­li­hood that in­creased costs will be passed on to con­sumers in the form of higher prices.

In any event, gold does not ben­e­fit from a mar­ket where in­ter­est rates are ris­ing, and this is ev­i­dent in the de­clin­ing gold price in the lead up to the re­cent Fed de­ci­sion.

Con­sider for a mo­ment the fol­low­ing sce­nario: Gold was trad­ing as high as $1,182 per ounce, with many an­a­lysts an­tic­i­pat­ing a rise to­wards the $1,200 level. How­ever, within a half hour af­ter the Fed de­ci­sion to re­tain in­ter­est rates at the cur­rent rate of 0% - 0.25%, the price of gold dropped by $30 an ounce. This re­sulted in the weak­est gold price in two weeks, down to $1,152 per ounce. We will likely see the price of gold mov­ing in a much nar­rower range be­tween $1,000

and $1,100 be­fore the end of the year.

The gold price and the US real in­ter­est rate tend to move in op­po­site di­rec­tions over the long-term. As the in­ter­est-rate in­creases, so the gold price de­creases and vice versa. This is not a fixed trend, and it cer­tainly fluc­tu­ates over time. In re­cent years, we have seen the gold price soar­ing as the in­ter­est rate de­clined. On Wed­nes­day, Oc­to­ber 28, the price of gold dropped by 1% to its low­est level for the month. By con­trast, the USD was trad­ing at its high­est level in some 75 days. The global head­winds that have be­come such an im­por­tant part of the Fed’s de­ci­sion not to hike rates did not even come into play in the last meet­ing.

That the cen­tral bank de­clined to dis­cuss the global eco­nomic risks of China and emerg­ing mar­ket economies is an im­por­tant omis­sion. It con­firms the Fed’s opin­ion that what hap­pens in global mar­kets is of lit­tle con­se­quence to the US mar­kets at this junc­ture.

The price of spot gold dropped to $1,155.86 (-0.9%) and gold fu­tures for de­liv­ery in De­cem­ber rose by 0.9% to close at $1,176.10 per ounce. Of­ten­times the ac­tual de­ci­sion is less im­por­tant than the ex­pla­na­tion for that de­ci­sion in the state­ment. That the FOMC state­ment did not in­clude any­thing sub­stan­tive about weaker Chi­nese data, emerg­ing mar­ket cur­rency weak­ness, com­mod­ity price weak­ness and so forth, was in­stru­men­tal in caus­ing the price of gold to re­verse di­rec­tion. Many in­sti­tu­tional traders and fund man­agers had set up stop losses for gold at $1,160, and that ac­cel­er­ated the de­cline to a multi-week low af­ter the Fed de­ci­sion.

Whether the doves or the hawks win out with the Fed de­ci­sion to raise in­ter­est rates re­mains to be seen. How­ever, the like­li­hood of a De­cem­ber 15/16 rate hike ap­pears to have grown given the sen­ti­ment ex­pressed in the FOMC state­ment. That in­ter­est rates have not been raised in nine years is an im­por­tant point, but it does not pre­clude the pos­si­bil­ity of a rate hike be­fore the end of the year.

In­vestors and traders have taken a mea­sured ap­proach to pre­cious met­als like gold, plat­inum and sil­ver, with plenty of short po­si­tions be­ing cov­ered by long po­si­tions.

The re­cent Fed state­ment was in­ten­tion­ally de­signed to leave the door open to a De­cem­ber rate hike, while not ex­pressly guar­an­tee­ing that it would take place. Al­ready we have seen the price of pre­cious met­als see­saw­ing, with sil­ver de­clin­ing to $15.80 per ounce and pal­la­dium drop­ping to $672.50. For its part, gold is star­ing down the bar­rel of its big­gest drop in nine weeks. Al­ready the price of this pre­cious me­tal is at 3-week low, with fur­ther drops likely.

It is pre­cisely this type of un­cer­tainty that gen­er­ates anx­i­ety among spec­u­la­tors in the world mar­ket. Gold tends to thrive in times of un­cer­tainty, but not when the un­cer­tainty re­lates to an in­ter­est rate hike that ad­versely af­fects the price of gold. It is clear that the gold price is fall­ing be­neath its 200-day mov­ing av­er­age, which will only ac­cel­er­ate short po­si­tions on the pre­cious me­tal. It is not only gold that has seen sharp de­clines in re­cent weeks; it is also pal­la­dium and sil­ver.

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