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The Kiss of Debt

By Jon Nadler       Printer Friendly Version Bookmark and Share
Aug 12 2009 4:04PM

Good Afternoon,

Gold longest slide in five months' time resumed overnight, with the precious metal dropping for a sixth consecutive session, this time to just under $940 for a short while, as the stronger dollar and a static crude oil price hampered its attempts to recover. The metal remained in 'pre-Fed' mode, but then again, so did a number of other markets (the US dollar for example) which awaited some kind of sensible words from the US central bank today. Dollar weakness has not been as helpful to commodities of late as it was in previous months.

New York's spot gold dealings opened the midweek session with a $1.80 loss, quoted at $943.50 per ounce. Awareness of the loss of another 3 tonnes of bullion from the largest gold ETF continued to keep the market in check, but few players were seen willing to drive the metal to the $930s prior to the Fed announcement, fearing that it might contain a "British-style surprise" statement on the continuation (or augmentation) of the ultra-liberal accommodative stance that the Fed and other central banks have become notorious for since 2007.

Thus, it was status quo in the gold pits this morning, but the price bias was still pointed into a southerly direction. The release of a higher US trade gap number for June failed to undermine the US dollar as of 8:30 NY time. Although the trade deficit rose by a billion from May's levels, it still underscores the lowest level of US imports in well over five years.

That "R" word, you know. Finally, we had the alarm bell of the day: Fed futures. They showed a US rate hike by April 2010. Not December of 2010. Not a misprint. Not what gold or other commodity players would like to hear at this juncture? Even if such pricing and expectations were pared following the Fed news release. Bets pulled back towards the third quarter after the announcement.

Silver lost one penny on the open, starting the day off at $14.27 per ounce. Platinum dropped only $1 to $1237 but palladium fell $3 to $269 as Wednesday's session got underway. In the background, the US dollar index was steady at 79.14, while crude oil managed a small, 20-cent gain, rising to $69.64 per barrel. US inventories of black gold expanded last week in the US according to EIA data.

And now, the much-awaited summary of the Fed statement: 1. No change in the Fed funds rate. 2. US economic activity is “leveling out? while financial market conditions and housing markets continue to show signs of “stabilization.? 3. The Fed sees inflation as “subdued for some time to come.? 4. The Fed will aim to maintain price stability. And…drum-roll,

5. The Fed is in the process of buying $300 billion of long-term Treasurys, but the FOM Committee will aim buy it all by the end October and then let the plan expire.If there was one take-home item from this afternoon’s Fed time at the microphone, this was it. The dollar took it as a cue to firm up, and it rose to 79.20 on the index. This is seen as the start of the mopping up of excess liquidity by the Fed.

Never mind the fact that interest rates are not seen as rising for the time being. It’s the cessation (after October) of the “monetization of debt? that had greenback traders on the offensive this afternoon. The headline about the Fed’s balance sheet concerns was consistent with expectations, and so was the position on debt buying. The new vocabulary we were offered today, referred to the US economy as now ‘leveling out’ rather than being in some kind of ‘stabilization’ mode any longer.

We offer you the most pertinent passage from the actual Fed statement for after-hours study. There will be not test. Feel free to trade against the Fed, if you like.

“The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time. In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets, and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage- backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve is in the process of buying $300 billion of Treasury securities. To promote a smooth transition in markets as these purchases of Treasury securities are completed, the Committee has decided to gradually slow the pace of these transactions and anticipates that the full amount will be purchase by the end of October. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.?

And so, we come to the afternoon trading hours. After having tried to rally to as high a level as $953.10 during the late morning, gold bullion retrenched following the aforementioned post-Fed dollar rally. Nervousness persisted in the metals pits, but the announcement puts the onus squarely on the bulls, as they now have to find whatever inflationary perceptional stimuli they might be seeking for a renewed rally in gold, in other places. The Fed did not offer much in the way of fodder this time around. Floor trading in the metal closed prior to the Fed news, thus we will not put much value on the after-hours developments in price, one way or the other. Let’s treat the developments as neutral, for the moment.

Silver rose 25 cents as participants made an ‘against the Fed’ trade of it today. The white metal rose to $14.53 an ounce by the afternoon hours. Platinum was up $3 at last check, while palladium lost $1 at $271 per ounce. It is entirely possible that a few players took the economic ‘leveling’ as a buying signal for silver and other industrial metals, but the former continues to be over-extended from a technical perspective and the low $14 area is seen as more of a ‘fair value’ given the findings of momentum studies.

The principal focus among various market participants remains the "R" word - as in, "recovery" - complete with all of its possible nuances. The timing and strength of the rebound, the collateral damage (lost jobs) it may come with, related central bank policies as regards the interest rate environment; these are all hot topics during this hot August. As regards the US, its central bank is widely expected to acknowledge that the American economy's recovery has begun. 

However, that there are sufficient numbers of credit/consumer/unemployment/real estate etc. landmines still to be found out there to provide an excuse for keeping rates near zero. The task -going forward- is the how and when to cut the Fed's balance sheet from the bloated $2 trillion of the moment, down to the $700+ billion it was prior to this global credit crunch.

A tall order, that, but, not an unmanageable one. Aside from these delicate surgeries to be performed by various central bankers, the confidence levels related to the global economy are certainly something to write home about. They jumped to their highest levels in nearly two years. What kind of "R" is this? Well, one that can -at present- only be labeled as "slowing contraction.'

Other central bankers took a bit of a bleaker view of the "R" underway in their own countries. The UK's Mervyn King opined this morning that the local version of the "R" word could well be "slow and protracted" whilst inflation may very well miss his institution's target for the next three years.

Two percent being that target, the Guv feels that a more than one percent undershoot could end up being the reality in Britain until around 2012. Complete with the -by now familiar- picture of the highest joblessness in a decade and a half. Over on the continent, the economic "R" was once again in question, following a surprise of a different kind. The unexpected 0.6% drop in industrial production recorded in June. So...the euro will now rally...on what?

Over in China, it was back to worrying about bank lending overnight. The SGE fell a hefty 4.7% this morning, repeating last week's swoon which eventually impacted gold as well. Chalk that up to the Beijing government jawboning about keeping the credit spigot on 'full' while in reality banks have already begun to tighten same, with a not-so-small wrench. What's a speculator to do? Why, sell, of course.

Something else that looks like a 'sell' is the basket of so-called commodity currencies. "A 37 percent drop in the Baltic Dry Index, a barometer of commodity prices, from this year's high may foreshadow losses in the dollars of Canada, Australia and New Zealand, countries that rely on raw-material exports."  reports Bloomberg in its commodity roundup this morning. We are all familiar (though some wish we were not) with the BDI. It collapsed at post-supernova rates last year. The Loonie, the Aussie and the Kiwi - the three amigos- track the BDI pretty closely. On occasion, so does gold.

Bloomberg also reports that: "The index collapsed in the wake of Lehman Brothers Holdings Inc.'s September bankruptcy. The Baltic Dry bottomed in December, rallied through June 3, and then tumbled. It fell for an eighth straight day on Aug. 10, reaching the lowest since May 20. Commodity currencies have rallied over the past five months.  Camilla Sutton, director of currency strategy at Scotia Capital Inc. in Toronto. "We've seen the index drop dramatically. It's a cautionary sign."

A Good Evening.

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal



Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.