In The Lead – QE: Quintessential Expectations

by Jon Nadler, Kitco Metals Inc. on June 4, 2012 · 0 comments

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Precious Metals CommentaryThe worst month for gold prices in 30 years was suddenly followed by the best daily climb since last August on Friday, the first day of the new month. The principal catalyst for the $66 upward move in bullion was the unexpectedly dismal report on May’s US job creation activity as reported by the US Labor Department.

Whereas economists had hoped to hear about 150,000 positions having been created in the US in May, the actual number of 69,000 (more on that later) was a stunner that immediately translated into a flare-up of expectations of another round of QE.

Indeed, if judged by the small (0.19) decline by the US dollar on the trade-weighted index and by a $1.24 euro at the end of the trading session, the out-sized move was largely anticipatory (of a QE) in nature even though — for a change- it did restore the typically inverse relationship between bullion and equities. As if on cue, most of the previously shelved hopes for some kind of QE by the Fed were dusted off and brought back to the gambling table like so many stacks of chips.

Investors are now once again actively "demanding" that the Fed to pump another several hundred billion into the financial system in order to keep bullion, equities, and anything but the dollar "shining." This would be the third year in a row when such clamoring for central bank action has become manifest in the spring and when market "tantrums" have been thrown whenever accommodation seemed to be not in the Fed’s game plan. The problem, of course, is that with rates already at record lows the QE "treatment" may prove to be about as effective as a placebo would be against a super-virus. But, there’s always hope, and you saw the consequences of it in action on Friday.

Of course, before such hopes can be turned into certainty, such players will have to keep parsing every single word related to monetary policy that comes out of the US central bank or out of the mouths of some of its official policy-making members. The Fed will "speak" after its June 19-20 meeting but a few of its team members have already been doing so, and often at odds with each other. Here is a small and very recent sampling:

Cleveland Fed President Sandra Pianalto said late last week that more Fed easing isn’t necessary even though the US may have to contend with slow-to-moderate growth and a relatively elevated jobless rate. Ms. Pianalto also said that Friday’s jobs report, taken by itself, "wasn’t likely to lead to a substantial change" in her outlook and thus didn’t change her view that the Fed should stand pat. She also believes that adjustments or the lack thereof for seasonal labor market swings may be at work in the dramatic changes we have seen from month to month on the that front.

Ms. Pianalto may be more than just minimally correct on her take, as it turns out. Consider the fact that while the Friday headlines tallied only 69,000 jobs as having been created in May, the "real" gain was on the order of… 789,000 positions. Kid you not. The Wall Street Journal notes that

"That much bigger number is what you get when look at the job figures that the Labor Department hasn’t adjusted for seasonal swings — like the tendency of hotels and home builders to hire more workers on as summer approaches."

Thus, the WSJ asks: "What’s The Real Jobs Number?"

How did we get to such a conundrum?

"The aim of the seasonal adjustment is to present data that more accurately reflects the underlying trend of the economy from month to month," according to statisticians.

However, even Fed Chairman Bernanke recently remarked that the

"seasonality issues that have arisen because of the unusually large recession in 2008 and 2009" were making economic data more difficult to interpret."

As for pol-iticians, well, some (candidate Romney) took the stat-isticians’ figures and used them as election year cannon fodder immediately after they were released. Fire in the hole!

On the other hand, also late last week, normally dovish Boston Fed President Eric Rosengren said that in light of the Friday news the Fed ought to prolong OT (Operation Twist) which is set to expire at month-end.

Mr. Rosengren feels that the extension of OT "would have the impact of helping to reduce longer- term interest rates without expanding our [Fed’s] balance sheet."

The knee-jerk price reaction to the US jobs data brought the yellow metal back to the trend-line which it had broken during the month of May. A number of other factors also played into gold’s Friday ascent, including first notice day, a good dose of panicky short-covering, and the jumping on-board of momentum-oriented speculators. "Game-changer" declarations were rolled out within hours. The same news outlets that just two weeks prior had labeled gold as having slipped into a bear market suddenly relayed the sense that perhaps gold’s safe-haven appeal had been rehabilitated with this move.

On the other hand, the by-now-all-too-familiar declarations of dollar doom and hyperinflation appear not to have panned out for their originators. In fact the US dollar is trading at about the same level on the trade-weighted index that it was at five years ago. In fact, inflation has not acquired the "hyper" prefix with a reading of 50% monthly price appreciation (which is what it would take to apply that label). What has happened, is, that the prognosticators of doom have either backpedaled on the scale of their projections or are actively avoiding revising such dire warnings.

Others, such as CNBC’s Oppenheimer analyst Carter Worth do not buy into the Friday gold bounce but see merely a throwback to resistance levels and an opportunity to still play the short-side of the market. Nevertheless, the Friday news release prompted Morgan Stanley to assess that the odds of some type of Fed accommodation are now up to 80% from 50%. Meanwhile, the view from the EW technical analysis camp notes the importance of the $1,527 support shelf in gold which was touched five times (and has thus far held). The late afternoon EW update however also cautions that gold’s sizeable move was not confirmed by silver and that an inter-market divergence has become manifest and could remain in place so long as silver stays under the $28.97 per ounce level.

This morning’s spot dealings started off with profit-taking action across the precious metals complex. Gold was bid at $1,617 down $9 per ounce while silver was off by 23 cents at $28.45 in New York. Spot platinum fell $9 to $1,434 and spot palladium declined $3 to $609 the ounce. Rhodium remained unchanged at $1,225 per ounce on the bid-side. News from China overnight was once again not very metals-friendly. It was reported in an official survey that China’s non-manufacturing industries expanded at the slowest pace in more than a year, as export orders declined and weakness in real estate countered strength in retailing and leasing. Thus, the country’s slowdown in manufacturing activity reported in May has now spread to the services sector as well.

Overnight, gold erased gains on emergent profit-taking, especially after on talk that Germany remains steadfast against participating in a continent-wide single bond issue to prop up its debt-saddled neighbors boosted demand for US dollars. In the background, crude oil continued to ooze lower, losing another 85 cents to $82.39 per barrel. The US dollar was also a tad lower, declining by 0.25 on the index to 82.76 while the euro clawed its way back to just above the $1.25 mark against it. Billionaire investor George Soros has opined that the EU has about 90 days during which to once and for all address the crisis that is threatening to undermine the single currency.

In technical terms, Friday’s price high in gold at $1,630 and change represents a .382 retracement of the decline from a previous wave high at $1,791 per ounce. A 50% retracement of the decline could bring prices up to $1,660 following which EW analysis expects another down wave. The key support remains at the aforementioned $1,527 mark and if that level is breached then prices should "cascade" lower.

ForexPros.com summarized the recent price action by corroborating the finding that Friday’s gains were prompted in part by "bargain hunters who perceived the ability of the yellow metal to hold the support zone near $1,530 as a buy signal and by short-covering activity that came into the market in the final half-hour of the last session of the week."

Silver was not as fortunate however; it still notched a 0.38% loss for the trading week despite the 2.6% advance that took place on Friday. The white metal remains inside its 12 week-old downtrend at this juncture. Platinum and palladium were able to eke out small gains for the week.

QE-related expectations have been the key driver in gold’s bull run, as the environment such accommodation engenders keeps interest rates and borrowing costs low, which makes gold and other commodities more attractive to play with, as compared with yield- or dividend-bearing assets such as bonds or stocks. Gold had gained as much as 15% early in the current year, hitting $1,790 an ounce after the Fed said in January that it probably would keep interest rates near zero until at least late 2014 and it also indicated that it could introduce a fresh round of asset-purchases. However, as soon as some perceived that the Fed was scaling back on its QE plans, gold prices lost almost 9% since late February, amid growing concerns the European debt crisis has been escalating; and event which has obviously fueled demand for the yellow metal’s natural "enemy" – the greenback.

Before the U.S. jobs data was released on Friday, gold prices had been marginally lower as the euro hovered near a two-year low against the U.S. dollar. Although gold’s appeal as a safe haven is normally boosted during times of economic uncertainty, the eurozone’s debt crisis has done little to bolster that type of appetite for the precious metal in recent months. A weakening euro and stronger dollar have weighed on gold instead, as the precious metal has been moving in tandem with riskier assets since hitting a record high of $1,920 last September. Gold was characterized as having lost its safe haven appeal to the dollar, U.S. Treasuries and German Bunds, partly as a strengthening dollar makes the metal less attractive to buyers holding other currencies.

Gold bargain-hunters are plain out of luck over in India, and, to some extent out of speculative "steam" in China, however. On Saturday, the local price for ten grams of gold (about one-third of an ounce) touched an all-time high of 30,000 rupees (up to 30,245 rupees in Kolkata), driven by a weakening Indian currency and by rising New York prices. A Morgan Stanley survey of urban and rural Indian would-be gold buyers found that based on consumer indications, the country’s annual gold demand might decline by at least 4% this year. In aggregate, Indians own about 20,000 tonnes of bullion which-at this juncture-is as much as 50% of their country’s GDP.

At the same time, the gold trade in China is slowing. Gold volumes traded on the SGE have declined below the monthly and annual average. The physical gold market has also been affected. India’s Business Line reports that:

"The Chinese Gold and Silver Exchange Society said that Hong Kong’s yuan-denominated gold trading volumes slumped 78 per cent from its January peak as sales at jewellery retailers has slowed."

"The President of the CGSES said that gold demand in China may stagnate this year. This is bad news for gold bulls because the Asian major has emerged as world’s largest consumer of gold. If two of the world’s largest markets — India and China — reduce their purchases, one can well imagine the impact on prices," notes the Indian business news outlet.

While we do not yet know the impact on prices, the fact that the global gold mining picture has experienced an undeniable shift from "peak gold" into a diametrically opposed paradigm should give some food for thought to some. Zeal LLC’s Adam Hamilton paints the following introductory picture of gold mine production in an otherwise lengthy but fascinating article on the subject matter:

"It wasn’t long ago that global gold-mine production had fallen to alarming lows. In 2008 this bellwether supply source was on the heels of a 5-year 13% decline, offering the markets its lowest output in 12 years. And this precipitous plunge had left folks scratching their heads considering gold demand was on the rise and its price was entrenched in a powerful secular bull. Thankfully this 2008 low would mark a major turning point in global mine production. And a powerful new uptrend formed that has seen volume rocket to an all-time high in just three years. According to estimates by the US Geological Survey, in 2011 mine production was up nearly 20% from 2008, to record volume of 2700 metric tons."

We close today on a lighter but still worth noting bit of statistical news. Question: Got your core ten percent "just-in-case" insurance position in gold set aside? Answer: Good. Consider yourself smart and prudent. Now however, consider certain alternative "assets" with which you can make some real money, crisis or no crisis, over a lifetime. Certain "liquid" assets come to mind. Real liquid assets such as… fine wine, for example.

On the occasion of the year of QE’s (Queen Elizabeth’s, that is) coronation, Britain’s This Is Money.co.UK ran a quick-and-dirty analysis on what one hundred quid invested back in 1952 would have blossomed into today and came away with certain startling conclusions.

Gold, as such, takes an honorable… fourth place in the roster of assets to have possibly plowed your vintage 1952 (British) money into, and that is a fine thing to be able to say about it. However, your gold investment would only be worth about 8,167 pounds today, versus the returns you would have achieved by having bought shares (of stock) and/or fine wine — the former worth 108,000 pounds and the latter an… intoxicating 478,000 pounds (tax-free!).

Inflation hedge? Sure, and then some. Plus, when Armageddon finally comes you could uncork that fine vintage Chateau Latour and "go out" in style with a smile on your face. "They" have always warned us that you cannot eat (or in this case drink) your gold…

Until Wednesday,

Jon Nadler

Senior Metals Analyst — Kitco Metals

Jon Nadler
Senior Metal Analyst

Kitco Metals Inc.
North America

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals 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 Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.

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