Why the Fed will Skyrocket Gold

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My views on gold are becoming increasingly bullish as the new year started and today could be the turning point that validates these sentiments. Gold volatility has been unusually low, with the 12 month standard deviation representing only 3.67% of the 12 month mean. I’ve argued on many occasions before that the lack of movement for gold is directly correlated to the lack of movement in the Federal Reserve’s balance sheet. But as I also recently wrote, all this is now changing.

Fed Balance Sheet Pops the $3 Trillion Dollar Mark

This is a point worth repeating. The Fed purchased a net of $95 billion dollars worth of assets in the last three weeks alone – that is about the market capitalization of Amazon.

See total Fed year to date purchases for January 2013 in units of 100s of millions of dollars:
Fed Asset Graph January 2013

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See total Fed balance sheet size in units of 100s of millions of dollars:
graph of total Fed balance sheet size

The projected base of purchases should force a more than $1 trillion dollar addition to their balance sheet by year’s end. My conservative prediction is that this balance sheet growth will translate into about a $2,000/oz gold price by year’s end.

Treasury Rates Guarantee Even More QE, Buying from the Fed

The Fed’s aggression level is likely to increase, perhaps as early as today as interest rates have started to rise in the US. The 10 year Treasury interest rate for the firs time in almost a year topped the 2% mark, an implicit ceiling target of the Fed.

See the 10 year Treasury note yield top 2% as of yesterday:
10 year treasury yield crosses 2% graph

The Fed is heavily restrained in how much they can allow interest rates to rise, both because of the effect on the economy and, perhaps more importantly, the impact on the Fed’s balance sheet. Keep in mind the Fed has a mere $50 billion in capital in relation to more than $3 trillion in assets. This means the Fed is effectively leveraged at a whopping 60 to 1 rate, many times more than Lehman Brothers when they failed, and more than half of their assets are represented by Treasuries. The Fed will not be comfortable sustaining even small losses despite the fact they can skirt reporting such losses, and the only way for them to ensure these rates stay capped or continue falling is to heighten the level of their purchases. If anyone is confused, keep in mind treasury yields trade inversely to prices.

A rising interest rate on securities the Fed is heavily exposed to is as good a leading indicator to more Fed buying as one can get – make sure you do not ignore this fact.

Follow What I Do Not What I Say

A part of what restrained gold from already breaking out was a widespread idea that the Fed was readying to end their purchases perhaps as early as mid 2013. This view arose out of an onslaught of news reports that seem to have read way too deeply into small remarks in the Fed’s minutes release of their last FOMC meeting.

What people fail to realize is that the dissenters in the Fed are not represented in the Fed leadership, who heavily shape policy, such as Chairman Ben Bernanke, vice chair Janet Yellen and New York Fed president Bill Dudley – all major doves. Moreover, these supposed hawks in the Fed are going to be easily shifted back when their growth outlooks fail, and the pressure from rising interest rates independent of the Fed forces their hand. The reality is the Fed often tries to use language to have its cake and eat it too, and by their nature are secretive about their true intentions so it is not worth reading much into lip service. Regardless to what some in the Fed are interpreted as saying, the balance sheet growth will not lie on the upside and so long as the fundamental forces supporting its growth remain in tact, the loose money impact on gold prices will show face.

Fed Statement, 2:15 EST

I’ll be back with an assessment following the Fed’s statement at 2:15. Now is the time to enter your bets as the roulette wheel is already spinning. Best of luck!

By Goldnews


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