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The Fed should be moderately pleased that it has some influence over the dollar and gold.
After hitting $1,032.20 spot on March 16 gold is trading at $917 spot this morning. This 11% plunge in price is barely worth mention to longer-term gold owners who are still holding a 38% profit over the last 12-months and a 9% gain year-to-date. Nevertheless, the threat is that the sharp correction in gold could mark the beginning of a much larger correction in commodity prices.
According to media reports, mention of the word ‘inflation’ in the Fed’s statement combined with a smaller than expect rate cut (75 bps instead of 100 bps) was enough to send gold traders running:
“Inflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully.” FOMC. March 18, 2007
While the Fed is unable to fix the credit market mess and/or stop the decline in U.S. home prices, market reaction to Tuesday’s statement supports the claim that the Fed can support the dollar when it chooses to do so. To be sure, after moving above 1.59 to the dollar on Monday the Euro is sitting at 1.545 this morning and after busting below 96 the USD/JPY is pushing 100 this morning. In other words, the mayhem that erupted last Friday with the Bear Stearns bailout has been erased from the memory of currency traders as both the Euro and Yen trade around the levels they were at on Thursday March 13. This is not to suggest that the worst is over for the dollar. Rather, only that the imminent demise of the U.S. dollar is no longer quite so imminent. Remembering that gold had been attracting investor interest this year because of the falling dollar, it is little wonder that the metal has corrected this week.
Gold is an excellent hedge against inflation, the only real alternative to a falling U.S. dollar, and a safe haven during times of financial crisis. However, it is not a good investment vehicle if the U.S. recession is about to drag the rest of the world into a slow down that negatively impacts commodity prices. Accordingly, gold investors today are left to wait for another financial crisis to erupt, a return of the dollar bear, and/or evidence that the expected slow down in the global economy will not be so slow as to further pummel commodity prices.
What if the U.S. slow down spreads, destruction in the financial markets doesn’t occur all at once, and the U.S. dollar does not do another nose dive right away? Well, and this is not to say that this week’s correction is the correction, but 2008 will have gone according to plan…
January 7, 2008: “Gold is headed for a historic bust akin to that of 1980. This bust will arrive once the U.S. economic slow down starts to deeply erode strength in emerging markets and/or once investors recognize that central banks are unable to quickly reflate the financial markets. With nearly everyone growing deeply enamored with the idea of ‘stagflation’, our gold bust theory is based upon the yet unseen threat of deflation.”
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