U.S. Fed's Mild Quantitative Easing Move Supports Gold

10 August 2010, 04:18 p.m. EST
By Allen Sykora
Of Kitco News

(Kitco News) -- A gloomier assessment of the economy from Federal Reserve officials, coupled with plans to resume buying U.S. Treasury securities, should be supportive for gold prices.

The developments are likely to exert some pressure on the U.S. dollar, which in turn tends to underpin gold, analysts said. Also, some investors may buy the precious metal as a hedge due to uneasiness about the economy.

Gold ticked higher in the immediate aftermath of a statement released by the Federal Open Market Committee at the end of a policy meeting Tuesday. Most-active December gold hit a high for the day of $1,209.90 an ounce on the Comex division of the New York Mercantile Exchange after earlier finishing the pit session $4.60 lower at $1,198. Around 3:45 p.m. EDT (1945 GMT), spot gold was at $1,204.50, which was $3.30 higher for the day and up from $1,196.40 about the time of the Fed statement.

“It supports gold in that it is going to weaken the dollar,” said Frank Lesh, broker and analyst with FuturePath Trading in Chicago.

The September dollar index fell to 80.95 from 81.40 just ahead of the FOMC release. Investors often buy gold as a hedge or alternative currency at times of dollar weakness, Lesh said. A softer dollar also makes all commodities cheaper in other currencies, which can boost demand.

Fed officials indicated they would leave interest rates low for an extended time, as widely expected. This in itself is supportive for gold, said George Gero, vice president with RBC Capital Markets Global Futures.

Furthermore, officials said they would reinvest principal payments from mortgage-backed securities in longer-term Treasury securities and also continue to roll over the Federal Reserve's holdings of Treasury securities as they mature. This is referred to as quantitative easing and a way for policy-makers to boost to the economy further when the target for the federal funds rate is about as low as it can go--zero to one-quarter percent.

Fed officials described any economic recovery as “more modest in the near term than had been anticipated.”

The Fed is continuing quantitative easing at a time when other nations, including the euro zone, are backing away from quantitative easing, said Mark Johnson, portfolio manager with USAA Precious Metals and Minerals Fund (USAGX).

“This would imply that the odds of a weaker dollar, going forward, have gone up slightly,” Johnson said. “That in turn would imply that the bull case for gold has been slightly enhanced.”

The planned Treasury-security purchase program “confirms the Fed is more concerned over economic prospects going forward than they had previously,” said Carlos Sanchez, analyst with CPM Group. This comes at a time when there are still worries among market participants about debt issues in some nations, plus potential for another shock to the global financial system.

“Investors will continue to buy gold, especially long-term investors, as a hedge against uncertainty over the economic prospects for the next couple of years,” Sanchez said. “Overall, we expect gold prices to remain around current levels going forward and trend higher for the remainder of the year.”

While the FOMC statement is supportive for gold, the metal has other factors in its favor as well, Johnson said. Many governments around the world will feel compelled to “reflate” their economies. Investors are likely to buy gold as protection due to worries about currency debasement, sovereign debt issues and an uncertain outlook for equities, he said.

Meanwhile, the federal-funds rate remains below the inflation rate factored  in by Treasury Inflation-Protected Securities. And, Johnson said, gold historically has fared well at times of so-called negative real interest rates.

“We think the upside potential (for gold) is greater than the downside risk, longer term,” Johnson said.    

Technically, last week's $1,213.30 high is a key near-term level for benchmark gold futures, Lesh said. If the market pokes above this, buy stops—pre-placed orders activated when certain chart points are hit—are likely to be triggered, Lesh said.

“You'll get some momentum buyers,” he said, listing the next upside levels at $1,221 and $1,235 an ounce.

Sanchez said he looks for gold to return to the $1,220 to $1,230 area in the foreseeable future, although there could be a pause there as some traders sell to exit positions and capture profits.

By Allen Sykora of Kitco News; asykora@kitco.com

Editor’s Note: Meet the Kitco News Team at the upcoming Kitco Metals eConference September 12-13, 2010. A not-to-be missed event featuring Ron Paul, Marc Faber and other industry heavyweights. The eConference is free with Pre- Registration www.kitcoeconf.com.