Moneypulation by the Fed

It is becoming increasingly difficult to navigate through the financial markets. Indeed, there is no doubt that the US market has recently been showing some weak fundamentals. We have realized, however, that whenever the government reports any economic data (retail sales, unemployment etc.), or whenever the stock market dips really low, there is a subsequent miracle rally in the S&P later that day. At the closing bell, the mainstream would rationalize the miracle rally by alluding to "better than expected" government data or "unseasonably warm" weather, and so forth. Most people have heard of the government "Plunge Protection Team," but is this mere conspiracy? Well, we believe it may be possible. Afterall, the intended purpose of the central bank is to "stabilize" the markets.


If the Fed intervenes in government securities, currencies, and the US stock market, then what about the gold market? Gold is of particular interest to the Fed because it provides the market with a yard stick to measure inflation. 10-year bond yields are also supposed to reflect inflation, but we know that excessively easy money (created by the central bank) has put a firm foot over long term yields. Thus, considereing the fact that inflation expectations are still low, it must be that the Fed is manipulating gold prices as well. Of course, gold has enjoyed a nice rally in the past several years. We believe, however, that the spot price has been constantly depressed through central bank gold loans and gold swaps that attempt to flood the market with excess supply. Looking at Friday's intraday chart, one should think: who in the world could unload so much gold in a matter of hours, and also, why.


The price of gold is driven by demand, not supply. Unlike other commodities, gold is exceptional in that it is not exhausted like oil or steel. Pretty much all the gold that has ever been mined still remain above ground - mostly in the vaults of central banks. This immense stock of gold (8,000 tonnes) is what enables the Fed to manipulate the gold supply, and hence depress the spot price. Of course, we do not expect this short-term, supply-driven scheme to last for long. The oversupply may be able to hide inflation on a short term basis, but it also provides a buying opportunity for astute gold investors (Chinese and S. Korean central banks to name a few) - and they will eventually request physical delivery. This means that even if the Fed engages in "paper sale" of gold through swaps, its physical gold reserve will inevitably bottom out. Gold demand will only increase as real inflation continues to pop up around the market, and the Fed will not be able to "whack-a-mole" everytime. Looking at the way gold spot trends, trades, and trends again, we remain bullish on gold and expect the next rally to commence soon.