After the last month of trading it’s become pretty clear that stock markets are facing an uphill battle going into the later part of the year. If this isn’t a fiscal mess were in now, it will sure do until the mess gets here…which it certainly will.
For better or for worse, financial markets worldwide have become conditioned to expect stimulus from the Federal Reserve when the going gets tough. It’s no wonder there’s a lot of speculation this week as to what will come out of Friday’s Federal Reserve synopsis in Jackson Hole. Stock markets have had one of their worst months since the financial crisis began, growth numbers have been revised down both here and in Europe, and economies on both sides of the Atlantic are teetering on the brink of another recession. The question now: What will the Fed do about it? Let’s take a look at some possible scenarios.
This time last year, Bernanke used his speech at the Jackson Hole meeting to hint toward the coming round of stimulus that was planned for later in the year. Two months later, the Fed began its second round of bond purchases, ushering in “QE2”. Before the Jackson Hole meeting last year, gold was trading around $1200 per ounce. In the three months following the meeting it soared to more than $1420, tacking on a total gain of more than 18%. Needless to say, any hint of additional stimulus would likely send gold much higher quite quickly.
Some Fed policy makers have worked to limit expectations of another round of bond purchases. James Bullard of the St. Louis Fed told Japanese reporters that though the Fed is prepared to take that step if necessary, he thinks the time is not right at the moment. Nonetheless, markets here in the states have begun to price in some sort of stimulus. Though the major US indices are still down more than 10% from last month’s levels, stock prices have recovered significantly over the last few sessions, betting that the Fed will take action to stop the bleeding.
This of course is a dangerous assumption because if the Fed makes the decision to stand pat for the time being to further assess the effects of the last two rounds of quantitative easing, the markets will surely react by giving up much of this week’s gains. If this happens, the flight to gold will likely pick back up where it left off. This could add significant short term upside to the gold market.
If the Fed does decide to launch another round of quantitative easing immediately, it will do so in the face of rising political opposition. As core inflation levels are on the rise, many in Washington are finally starting to put the pieces together. Another round of QE would certainly contribute to the long term inflationary pressures which are sure to rise in the coming years. The fact that the $600 billion of bond purchasing already conducted by the Fed has had little positive effect on the overall economy is leading many to question the wisdom of the QE program.
With all that said, interest rates are already at near zero and there is little the Fed can do other than instituting more bond purchases to keep the economy from sliding back into recession. There is nothing in their track record to suggest that they will not use any and all options available to them to keep the economy moving ahead, albeit at an anemic crawl.
If (or when) the Fed does announce the next round of bond purchases, it’s a virtual guarantee that gold prices will respond with a significant move to the upside. There is nothing gold likes better than loose, inflationary monetary policy. That said, the short term effects that any more quantitative easing will have on the gold price will probably be insignificant compared with the price increases that will surely come when inflation starts to show in earnest. Keep in mind that gold has risen to over $1900 per ounce on speculation that inflation is coming down the line. Imagine what it will do when inflation actually arrives. There is nothing like daily price increases on basic goods and services to drive people to buy gold, the ultimate inflation hedge. It’s like we said: If this isn’t the mess, it will surely do till the mess arrives. Either way, the midterm picture for gold looks extremely strong as either direction chosen by the Fed will likely contribute to higher prices.