Gold Prices Should Appreciate as the Fed’s Hands are Tied

Gold prices should appreciate after the Fed meeting this week. Gold prices have been burdened by the strengthening dollar for the past couple of years. The dollar strengthened again last week thanks to extraordinary language from the European Central Bank (ECB), but gold hardly budged while oil prices plunged. Gold’s strength appeared to be due to expectations about the Fed policy decision this week, or rather its likely indecision. The Fed will probably not raise interest rates this week, given recently soft U.S. economic indications and the strong position of the ECB in the opposite direction (expansionary policy). If I am correct about the Fed, gold prices should be cleared to appreciate further near term. As time progresses and the economic recovery solidifies in Europe and China growth stabilizes, dollar strength should fade. As a result, gold gains a solid footing for the long term as well.

Gold prices have come down from their heights reached during the financial crisis and the Great Recession. Economic and financial market recovery in the U.S., especially against relative weakness overseas, allowed for dollar strengthening and the beginning of gold’s downturn even despite easy money policy at the Fed. More recently over the past two years, the Fed’s plans to normalize monetary policy against the backdrop of still looser-for-longer policy overseas has given the dollar even more relative strength, and priced down gold in dollar terms. But the perspective of investors could change today when the Federal Open Market Committee (FOMC) issues its October decision.

If, as I anticipate, the Fed refrains from raising interest rates, it will signal to investors that its hands are tied. Recent volatility in U.S. securities markets has illustrated popular concerns about the risk of economic contagion from China’s slowdown, and now also from the impact of new obstacles to Europe’s recovery. It’s also notable that U.S. energy sector contraction due to depressed energy prices has seriously infected the U.S. manufacturing sector. The latest Employment Situation Report showing slower job growth, supported by the latest bad news about manufacturing in yesterday’s Durable Goods Orders, and even the new home market earlier this week, gives the Fed good reason to wait a while longer.

And the European Central Bank’s (ECB) strongly worded statements last week served to remind the Fed how its divergence would impact the U.S. dollar given its nascent gains. Further dollar strength would do more harm to commodity prices and the business of a great many American multinationals and energy miners.

The Fed made certain to keep investors at the ready for its first rate hike at its heralded September call. But this week’s meeting may show investors the Fed is not in a position to act on its warning yet. The tone of Fed member discussion has changed as well since the press conference of the Fed Chair post the last monetary policy decision. After the jobs report falloff, Fed members stuck to their indications about a potential action this year, but emphasized “later” this year. That would include the Fed’s December meeting, after which it will provide a press conference. The Fed indicated it could act in October and schedule an impromptu press conference to discuss its actions, but that extra effort seems unlikely now. Still, the uncertainty about the possibility has likely held gold back until now.

I anticipate the dollar will give back much if not all of its latest gains when/if the Fed does not act to begin monetary tightening this week. Even if the Fed continues to emphasize the possibility of a December action, its actions will speak louder than its words on Wednesday. Take note that the longer the Fed’s inaction continues, the more likely Europe and China are to stabilize and no longer require extraordinary monetary policy support from their central banks. At that point, the dollar’s muscle flexing should end, and gold finds a surer long-term footing.

The value of the dollar is critical to the price of gold, just as it is to all commodities, which are also currently seeing depressed pricing. Gold differs from commodities like oil, though, because it has significantly fewer industrial uses and because it is seen by many as a currency in times of global distress, or for Americans, dollar concerns (inflation, domestic catastrophe etc.). Gold is impacted by other factors, including supply and cost of production, but currently, the fluctuating and in my opinion extreme upswing in the dollar is weighing more heavily than other factors.