Why Gold Plunged on Friday and The Feds ‘Stealth Quantitative Easing’

Traders were clearly positioned wrong.

Stock Markets soared. Gold plunged.

The catalyst?

A ‘partial’ trade deal between the US and China. According to Bloomberg:

The U.S. and China agreed on the outlines of a partial trade accord Friday that President Donald Trump said he and his counterpart Xi Jinping could sign as soon as next month. As part of the deal, China would significantly step up purchases of U.S. agricultural commodities, agree to certain intellectual-property measures and concessions related to financial services and currency, Trump said Friday at the White House. In exchange, the U.S. will delay a tariff increase due next week as the deal is finalized, though new levies scheduled for December haven’t yet been called off.

So, they’ve agreed to ‘the outlines of a partial trade’ deal. On the surface, it looks good for the US. And, ‘not bad’ for China. They simply get a delay in a planned tariff increase for their trouble.

Trade war: Look at getting your money out of this Aussie sector ASAP

There will obviously be more trade related surprises ahead. But for now, let’s look at the market response.

The Dow jumped 1.2%, while the S&P500 and the NASDAQ increased 1% and 1.3% respectively. Gold futures fell 0.8%. But it was the gold stocks that took a beating on Friday.

The ‘gold bugs index’, the HUI, sank 4.5%. The Van Eck Vectors Junior Gold Miners ETF fell 3.2%. Clearly, gold investors expected a different outcome on the trade talks.

Let’s put these falls into perspective, though. Have a look at a chart of the HUI, below.

NTSE Arca Gold Bugs Index - HUI (WI) 1 Day Bar Chart - USD - 14-10-19

Source: Optuma

[Click to open in a new window]

The index is simply consolidating after a very powerful move. From the May low to the August high, the HUI surged more than 60%. That’s a huge move in three months. A correction should not come as a surprise.

It would be good to see prices hold above the 100-day moving average (red line). A few months of sideways movement would then lay the platform for another move higher.

There is a risk that prices fall back to 180 on the index. This is where prices gapped up in June. But I see this as a lower probability risk right now.

Is this Stealth Quantitative Easing?

The unknown is how the market responds to the latest moves from the Fed. This news didn’t get much airplay due to the trade deal. But it’s important. From Bloomberg:

The Fed said Friday it will begin buying $60 billion of Treasury bills per month — with maturities ranging from five weeks to a year — at least through the second quarter of 2020 to improve its control over the benchmark rate it uses to guide monetary policy. It’s the central bank’s latest measure meant to prevent a repeat of the mid-September turmoil that rocked money markets.

The ‘turmoil’, you may recall, was when repo rates surged for a few days in September. It was a sign of the Fed losing control of interest rates. Apparently, there weren’t enough reserves in the system to cover demand spikes.

The Fed wants to rectify that by pumping US$60 billion a month into the markets for the next six months or so. But it’s doing so by buying short-term treasury bills, which are cash like instruments.

In other words, it’s changing the mix of cash in the system in order to boost bank reserves. Is this stealth QE (Quantitative Easing)? The best explanation I read was from James Mackintosh from the Wall Street Journal:

Many people are confused about how money works, and think banks lend based on reserves, somehow multiplying the amount of reserve money the Fed creates. Quite apart from the dismal failure of Japan’s early experiment with boosting reserves, a simple fact should help destroy this myth: from their 1988 peak to the 2000 low, Fed reserves fell 87% while bank lending rose by a quarter. The U.S. monetary system is based on the price of reserve money, not the quantity of reserve money; fiddling with the amount of reserves matters only insofar as it affects the price—and the renewed Treasury buying is designed not to affect the price.

The US monetary system is about the price of reserve money then, not the quantity.

Fair enough.

But is it not a little worrying that the Fed sees the need to increase the quantity of reserves by US$60 billion per month, just to keep prices stable?

Even if there is calm on the surface, it tells me there is turbulence underneath.

The Fed cannot disentangle itself from the market. Any attempt to do so just makes it worse.

It won’t be happy until it has flatlined the whole stock market. In the years to come, it will have increased the quantity of money so much, that it ceases to have any meaning.

Stock prices and investors will grow numb. There will be no life (volatility) in the market. It will be a listless state-owned enterprise, full of parasites feeding off its half-dead carcass.

Welcome to the future.



Greg Canavan,
Editor, The Rum Rebellion

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