Friday, January 8, 2010

Rate Increase Speculation Drives Gold Down

Spot gold spent most of yesterday in a trading range, between US$1,128 and $1,135. Once after-hours trading began, though, that range was broken on the downside. Last evening, gold slid down to about $1,122.50 and stayed in that range; it bottomed at $1,120 in the wee hours of the morning. Since then, a new range was established between $1,120 and $1,125. A definite slump, but still above the late December lows.

The decline was set off by speculation of the most-watched shoe to drop right now: an increase in the U.S. Fed Funds rate. The head of the Kansas City Fed, Thomas Hoenig, has been quoted as saying the Fed Funds rate should be at about 4%. A nice helpful bulletin has been sent out to American financial institutions from the Fed about managing interest-rate risk. Put together, with Hoenig acting as the bad cop, the Fed is clearly signaling the end game for zero-interest-rate policy. Given the campaign, the beginning of the end seems to have been moved up. The market has expected the hike to come in June, but March is now a possibility.

Of course, an alternate reading on the campaign is that June is still the target date. If so, then the Fed is very worried about the conditions of the banks. Central bank policy was untelegraphed in the olden days, as unanticipated changes modify behavior better. Advanced signaling is a relatively recent development. Giving almost six months' notice is unprecedented. If March passes with no rate hike, then it's a sign that the Fed still sees some sick banks under its purview.

For all I know, yesterday's campaign was a test. The Fed could have been testing the waters to see if to-the-point talk about rate hikes will cause the bank stocks to crumble, like they did in February after Commerce Secretary Geithner's announcement of a too-vague rescue plan. If they had any effect, Hoenig's words pushed the bank stocks up slightly. The interest-rate-risk circular was announced at 3 PM ET, and its release did not trigger a last-hour selloff of bank stocks. Given that lack of sell-off, the Fed may decide to move the rate hike schedule up to the spring. The greenback did react yesterday, but not by much. 78 on the U.S. dollar index was not decisively surpassed until this morning, until a certain news release hit the screens.

This Bloomberg report attributes the drop in gold to the strengthening greenback. In addition to quoting a bullish trader, it also quotes a group of dollar bulls and a near-term bear:
The dollar index yesterday rose the most since Dec. 17. The currency may climb about 15 percent this quarter, Royal Bank of Scotland analysts wrote in a report e-mailed yesterday. [That climb would push the U.S. dollar index to just below 90, slightly above its March '09 high. The analysts evidently expect a repeat of the greenback's rocket-up that took place between June and November of '08 - DMR.] Bullion might fall to $1,030 an ounce in coming months as the dollar rebounds [to an unspecified level], Philip Klapwijk, executive chairman of gold researcher, GFMS Ltd. said today in a Bloomberg TV interview.
However, most traders are bullish. "Fourteen of 20 traders, investors and analysts surveyed by Bloomberg News, or 70 percent, said bullion would gain next week. Six forecast lower prices. "

This morning's Wall Street Journal Online report starts off with a theme touched upon by the Bloomberg one: gold traders are acting cautiously ahead of U.S. non-farm payroll data. That payroll data has now been released, and has disappointed. The 85,000 job drop was well below consensus expectations of a 15,000 job rise. The unemployment rate stayed flat at 10%.

The greenback has plummeted on the news, falling from 78.188 to below 77.5. Gold has shot up: as I write this post, spot gold's at $1,136.40. Evidently, there's been a lot of behavior modification due to that jobs report.

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