Gold: What IMF Sale?; Discount Rate Hike Takes Priority

For an event that was supposed to rock the gold market, the IMF sale has proven to be a one-hit wonder (so to speak.) An initial run-up at the start of regular trading was blocked, but the pull-down merely led to a pause. By 8:50 AM ET, gold was rising once again. A second pause kicked in as of 9:30 AM ET, but the resultant range was near the top of the forty-minute move: $1,115-$1,118. It stayed in that range for nearly an hour, before dipping slightly to $1,114. Then, the price rose again in a swift move that topped at $1,123.50 right at 11 AM. The release of the Index of Leading Indicators for January seems to have had an influence on the rally, even though the number was weaker than the expected 0.5%. It's more plausible that the better-than-expected Philly Fed Index number had an upward influence, as recovery foreshadows inflation.

Another pullback followed after 11, which took gold down below $1,118 before ending and revewrsing slightly. As of 11:25 AM ET, spot gold was at $1,117.20. The Kitco Gold Index divided up the daily gain of $12.50 into $10.90 due to predominant buying and a $0.50 loss due to U.S. dollar strength. At this level, it's almost as if the IMF announcement had never been made.

What weakness there was in the U.S. Dollar Index vanished by 11:18. After bottoming from an early morning decline at 80.17, the Index recovered some of its loss by pulling up to the 80.4 level as of 10:35. A quick double top presaged a mild pullback, ending at the 80.3 level as of 10:58, but the uptrend resumed. 80.45 was taken out, followed by a dip to 80.4 and a new mid-morning high. As of 11:27 AM ET, the Index was rolling at 80.57.

It's an odd combination given recent behaviors and gold's long-established habits: gold and the greenback rising more in tandem than in mirror image. The last time this happened, the incongruity was resolved to the detriment of gold. There's no sign of that happening for this tandem run, so far.


Update: The inconsistency was resolved in favor of the greenback, until recently, and gold was pushed down a little. From 11 AM to 12:15 PM, the metal's price slid down in a decelerating drop that ended just below $1,114. Since then, it's been in a trading range between the $1,114 and $1,116 levels. As of 1:18, spot gold's at $1,115.50 for a gain of $8.70 on the day. Kitco's Gold Index has the gain divvied up into $9.85 due to predominant buying and a $1.15 subtraction due to U.S. dollar strength.

The U.S. Dollar Index did wind up weakening after finishing its run at 80.7218 as of 12:10 PM. The entire run lasted for more than an hour and a quarter, carrying the Index more than 41 basis points upwards. Since that 12:10 top, it slid down in a two-step drop that carried it down to 80.5263 as of 1 PM ET. A double bottom was made five minutes later, prefacing an upwards reversal that topped out just below 80.6 as of 1:10 PM. As of 1:20 PM, the Index was at 80.57.

Although the USD INX did gain some ground back, there was a spell of weakness which gold didn't follow through upon by rising up. The most likely reason why is that the gold market got a little ahead of itself and didn't digest the strength in the greenback properly. The U.S. dollar may coontinue to fall from here. If gold doesn't play off against it, then it's likely that this morning's gains are being digested. The rest of the afternoon will tell.


Update 2: And another curveball was thrown at the gold market, which packed enough punch for another large drop. This one had about 1 1/2 times the impact of the announced IMF sale. The Federal Reserve, in its shift from deflation fears to normalization mode (or inflation worries), has hiked the discount rate to 0.75% from 0.50%.

This rate isn't the same as the Fed Funds rate; it's the rate at which banks are fronted money on loans they bring in as collateral.

"The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy," [the Fed said] said.

It's true that the normal discount-rate premium is about 1% above the Fed Funds rate, and today's hike raises that premium from 0.25-0.5% to 0.5-0.75%. The markets, however, have taken it as a tightening. Stock futures fell, and the announcement was good enough for a $15/oz drop in gold. The U.S. Dollar Index has benefitted hugely, exploding upwards from 80.39 to 81.00 in the space of less than ten minutes.

Evidently, the imminence of a rate hike - even one in the discount rate - has not been anticipated by the markets. It remains to be seen, though, how each market will react tomorrow. The Jan. 12th announcement of a reserve-ratio hike by the People's Bank of China was enough to completely derail a gold recovery at about thirty dollars an ounce above this afternoon's high; the second such announcement only affected the gold market interday. The same absorption rule may apply to this move and the Fed's next one.

Before the announcement, gold had reversed its late-morning decline and managed to climb up well above $1,120. That level was reached as of 2 PM ET, and gold spent an hour and twenty minutes bumping up against it until breaking through to $1,122 as of 3:25 PM. A period of indecision followed as gold bobbed around that level until the Fed announcement. After plummeting that $15 per ounce, a period of rest ensued and gold closed the day at $1,108.10. Surprisingly, there was still a small gain on the day: $1.30. The Kitco Gold Index credited the metal with $8.00 worth of rise due to predominant buying and debited $6.70 for the strengthening of the U.S. dollar.

Some perspective may be of help. As of 5:30 PM ET, the U.S. Dollar Index was at 80.93 for a record unmatched since last June. And yet, gold is well above the level which it was at when the Index last touched a multi-month high - Feb. 12th. Tht day, gold closed at $1,092.40.

A daily chart of the Index's moves could provide fodder for the "guess the surprise" game. As far as I can tell, there was no way to do so from today's closing chart (from Stockcharts.com), whose data ends before the Fed's announcement:



By my lights, there was no anticipatory move except for an underlying strength...despite the lopsidedness of non-commercial longs in the dollar/euro market. All the chart shows is a trading range, which could be chalked up to an expectation of (or a hope for) more trouble in Euroland. Those longs who weren't shaken out by the recent turbulence have reason to celebrate. As of 6:23 PM ET, the Index continued shooting up after a post-announcment pullback; it was at 81.18 at that time. I note that the widespread success in the dollar-long trade, despite the recent turbulence, will make the greenback-long the place to be for the nonce. That's what happens when the crowd is successful in speculating. The ones who bailed out in the last few days are almost certainly kicking themselves for being impatient (or undermargined.)

The interday action gave even less clue of what was coming. Before the Fed announcement, the Index was drifting downwards slightly, although basically in a trading range. It was in one from 2 PM to 6:20 PM, bordered by 80.47 on the upside and 80.37 on the downside. Just prior to the announcement, the Index had slipped to the bottom of the range and looked like it was going to penetrate on the downside. If the Fed were expecting to send a jolt to the system, the behavior of the greenback shows that it succeeded.

Gold, of course, was shocked too. This 1-year chart, also from Stockcharts.com, shows the effect of the discount-rate hike at the very end:



From the 1-year persective, this afternoon's spill looks little more than a continuation of a short-term holding pattern. The MACD indicator, found at bottom, is still bullish - but I note that the RSI line (at top) topped out just above the 50 level, where it has been wont to turn in the last two months. That being said, it's still above 50 even after the spill.

There are those who think that the Fed et al. are deliberately pushing down the price of gold. I'll credit them to this extent: it's a possibility that gold is being watched by Fed staff as a future-inflation gauge, and recent strength ex-greenback has been taken as a sign that it's time to worry about inflation. The People's Bank of China likely uses similar reasoning, although for a more direct motive given the PRC's desire to obtain more gold for reserves (at a low price, of course.)

Moving to more quotidian matters, the Gold:GLD Index, calculated by dividing the price of gold by the price of one GLD share, got below 10 interday. That level means that gold, at some point in the day, was trading at a discount to the SPDR Gold Trust's paper alternative. (Each share represents 1/10 oz of gold.) That drop, interday, makes for the third time this month that the indicator has flashed so. To the extent that it's an oversold indicator, it is signalling an oversold condition as it has on Feb. 1st and Feb. 7th. A chart of the ratio is here.

Moving back to the discount-rate hike, the timing of it may seem odd to some because consumer credit was still contracting for the 11th straight month as of December. [Data here.] After all, why tighten before consumer credit has turned up? Why be pre-emptive? Discount-window borrowings have been contracting too, so interpreting the hike as a disguised symbol for the banks to get out and lend isn't very plausible. Had the banks been using the discount window as a carry-trade device to buy U.S. Treasuries and short-circuit credit growth, it would have shown on the chart. All that appears is a huge amount borrowed during the financial crisis that's been gradually tailing off. There's no sign of discount-window hoggishness over the last year.

It could be that the Fed wants to hurry the process of getting discount-window borowings down, and is sending a message to its member banks to cut down further. A more likely explanantion is that recent economic data has convinced the Fed that the recession is truly over and recovery is here; hence, it's time to start normalizing. At any rate, that august institution managed a market-unexpected shift in policy - at least, in terms of timing. Once the excitement (and panic) subsides tomorrow, the extent to which gold has already discounted such a shift will be seen. The excitement in the greenback is likely to continue, even if a refreshment pullback ensues.

Unless another surprise is awaiting us...


Postscript: This doesn't count as a surpise, but the gold market has contiuned to take the Fed news badly. The price of the metal fell a further $6/oz shortly after evening trading opened. After a pause, gold fell further; it dropped below the $1,100 level at around 7 PM ET. As of 7:15, the metal is just above that level at $1,100.80. So far, $1,100 has held; as of 7:57 PM, gold climbed back up to $1,106.30 - almost at closing level. The greenback has had its influence on the metal.

More specifically, the U.S. dollar shot up just beforehand. As at 6:51 PM ET, the Index rocketed as high as 81.3597 before pulling back to the 81.2 level. A further post-7-PM drop put the Index well below 81.15, before it veered in on that level as things calm down.

Markets are made by people, of course, and this drop shows the evening traders getting their first crack at the metal and the greenback post-announcement. There may be other drops in gold as traders in different countries and time zones hear about the news and react to it too, but the bounce-back makes another attempt less likely as of now.


Postscript 2: At least two FOMC members (Fed governor Elizabeth Duke, Fed bank of Atlanta president Dennis Lockhart) have said publicly that the hike was not a tightening, even though the markets have been taking it as one. Given that reaction and the denials - normally, one person steps up to the plate - a hike in the Fed Funds rate itself isn't likely in the near term.

Bill Gross of Pimco has stated that he himself doesn't believe it's a tightening move or a signal of the imminence of one.