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