Gold (again) hits new record on deflation fears

Good Morning,

The subtle language change that the Fed injected into its post-meeting statement unleashed a torrent of dollar sellers and additional gold buying in the ensuing afternoon and overnight hours. The mere mention of ‘preparedness’ as regards additional accommodation (likely in the form of bond purchases), even if made conditional upon the US economy showing signs that it clearly needs it, was more than sufficient for the throngs of bettors to bet the way they have.

The Fed exhibited a continuing obsession with deflation and the need to avoid falling into that spiral at all costs. However, such preoccupation was actually wrapped in language that alluded to inflation running at “levels somewhat below the Fed’s mandate to promote maximum employment and price stability.”

Translation: while everyone is piling into inflation-mitigating assets, the clear and present danger is being posed by the inverse of that phenomenon. The Fed would like nearly 2% inflation, yet the economy has offered just 0.9% over the past year (to wit, the Japan-style talk of “desirable levels of inflation” and how to bring them about).

Whether or not one thereby needs to utterly skew a portfolio as if multiples of that yet-to-be-felt 2% inflation level were manifest, is, of course, another story entirely. This, however, is the present flavor of market betting. Speculation, thy new name is overreaction. Happened in 1980, too. Until 1982 came around.

At the end of the day, the Bernanke anti-deflation campaign is based on some serious external field experience (see Japan) and not just on his intense personal focus on the myriad causes the engendered the Great Depression. Chief among such perceived catalysts for the huge contraction of the early ‘30s was the Fed’s apparent reduction of the money supply.

Well, there is a way to take care of that misstep; behold the Fed’s actions since the fall of 2007. However, lest we believe that Mr. B has some kind of ‘carte blanche’ to do any of what might be done (and ‘might’ needs to be stressed emphatically), consider that his team is not offering him quite nearly the full cooperation that many believe is critical.

From the very text of the Fed statement, a glimpse into continuing dissent by one of Mr. B’s own team members: “Voting against the policy was Thomas M. Hoenig, who judged that the economy continues to recover at a moderate pace. Accordingly, he believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted and will lead to future imbalances that undermine stable long-run growth. In addition, given economic and financial conditions, Mr. Hoenig did not believe that continuing to reinvest principal payments from its securities holdings was required to support the Committee’s policy objectives.” Six such objections later, Mr. Hoenig is still not quite being heard clearly.

With no one at all seeing any adverse conditions that might derail the exponentially growing mountain of longs in bullion, institutional sources rushed ahead of each other to raise their gold forecasts overnight. Meanwhile, the yellow metal took cues from a US dollar that dipped under the 80-mark on the index and climbed to within four dollars of the next century mark on the price scale.

As expected, while the futures and options players were out raving following the Fed, Indian buying withered some more. The growing availability of bullion bars made from scrapped gold tilted the local spot market towards a larger discount and further ate into primary dealers' bullion sales. "I am hearing of a discount of about 5,000 rupees (per kg) in Chennai spot market, which is affecting our sales" said a bullion dealer from a state-run bank’s trading desk overnight. Similar trends are underway in Thailand and Indonesia as the core market is struggling amid the maelstrom brought on by the spec funds and their millions.

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