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As the US industrial output
shrank last month for the first time in over a year, it appears certain that
the Federal Reserve will decide to release more monetary stimulus on its next
policy meeting on November 2-3. A report on Monday revealed that home-builder
confidence might have risen this month but it remains worryingly low.
According to Paul Ashworth of Capital Economics based in Toronto, "The industrial
production report illustrates, if anything, economic growth is still slowing
rather than beginning to pick up again, which is yet another reason for the
Fed to unleash QE2 (second quantitative easing)".
Industrial output fell by 0.2% in
September. Economists have expected to it rise by 0.2%, the same level as
August. Overall, it is clear that recovery has slowed dramatically, leaving
inflation too low and the unemployment rate too high. Frustration among the
unemployed can deal a blow to the Democratic Party in the congressional
elections. Most expect the Republicans to gain control over the US House of
Representatives as well as win some seats in the Senate.
Questions about the Stimulus Size
While more monetary policy easing is
expected, Fed Chairman Ben Bernanke offered little clue as to the size of the
asset purchase program. The US stocks ended higher because of
better-than-expected performance from Citigroup. In addition, bargain hunters
also helped lift the price of government debt. Overall though, financial
markets were hardly moved by the recent economic data.
Production at the country's refineries,
factories, and mines increased at an annual rate of 4.8& for the third
quarter. This is down from 7% in the second quarter. Consumer goods
manufacturing declined for the second straight month. Aaron Smith of Moody's
Economy.com in Pennsylvania said that, "It reinforces our belief that
inventory accumulation has god a little bit ahead of itself and most likely
will have to come down and this is going to weigh on output over several
months". Meanwhile, utilities output dropped by 1.9% while mining output
rose by 0.7% last month.
Gold Forecast
Citing expectations of quantitative
easing, Goldman Sachs raised its 12-month forecast for gold to $1,650 an
ounce. It also expects long-term interest rates to continue its downward
movement. The Goldman Report, authored by Damien Courvalin and David Greely
said that, "With the US real interest rates pushing lower off the
slowdown in the pace of the US economic recovery and the growing prospect of
another round of quantitative easing, we expect gold prices to continue to
climb."
The report added that, "Despite
the rebound in net speculative length, it remains well below levels
consistent with the current low US real interest rate environment." The
decline is bound to persist with rates even going lower over the near-term
once the Fed undertakes QE measures. As a result, Goldman raised its gold
price forecast to $1,400 in three months, $1,525 in six months, and $1,650 in
12 months.
Goldman reports, "The return to
quantitative easing will likely be a strong catalyst to drive gold prices
higher, and we expect the gold price rally to continue until US monetary
policy begins to tighten." This rally, which began in August, was
significantly driven by the plummeting yields of 10-year US Treasury
Inflation-Protected Securities.
The yield is closer to 0.50% rather
than the 1.0% in previous forecasts. Other factors that played a role in
gold's continual rise include the demand from central banks and gold
exchange-traded funds. However, the bank also added that there is a
considerable downside risks associated with gold over the long term,
especially once the Fed tightens monetary policy earlier than projected
(which we doubt, as at this point "inflating the problems away"
appears to be the only viable solution to the economic problems).
Now, let's take a look at the long-term
chart (courtesy of http://stockcharts.com) above. The gold has moved
up to the upper borders of the long-term trading channel. However, it looks
set for a correction soon. Gold appears incapable of breaking above the
resistance line at this point and the rally this week doesn't look like it
can delay the correction much longer. Still, once things will have all
settled down, another powerful rally is likely to being - perhaps taking gold
to $1,500.
Gold vs. Treasuries
Market indications these days are
difficult to comprehend. In school, economists were taught that falling
10-year Treasury yield is an indication that the economy can expect a strong
currency and low inflation. But right now, the dollar has already fallen 12%
since June while the price of gold continues to breach all-time highs. The
increasing price of the precious metal is indicating hyperinflation even as
bonds are showing warning signs of deflation.
The last time the US experienced severe
economic problem was in the late '70s and early '80s. At the time, the
Treasury and the gold market showed better "coordination". Thirty
years ago, the Fed's depression of the interest rates led to sharp inflation,
a weak dollar, and significant increase in the price of gold. More
importantly, Treasury yields skyrocketed as investors demanded better rates
for the risks they're taking. Basically, everything made sense.
The environment today is almost the
same to the occurrence 30 years ago, except that the 10-year notes plummeted
to 2.4% today from 6.6% back in 2000. But other components are the same. For
example, the monetary base surged both then and now - this time, instead of
doubling over an eight year period, it has tripled in 12 years (from $621
billion in 2000 to $2 trillion today). The dollar price of the yellow metal
has quadrupled even as the US dollar dropped 35% of its value.
It is only possible to take advantage
of low-interest rates if a country has low inflation, stable monetary policy,
high savings rate, and low debt levels. US consumers currently have very low
savings rate at 5.8%. Personal savings rate of American consumers have
bordered on negligible, sometimes even negative, from 1998 to 2008. With the
national debt at 93% and annual deficit at 9% of gross domestic product
(GDP), low interest rates may exist over a long timeframe.
For some analyst, it appears that the
Federal Reserve wants Americans to anticipate inflation to encourage them to
spend more money now. Also, by spreading the belief that prices will start
rising in a fast pace, the Fed can effectively reduce inflation-adjusted
interest rates while stimulating the economy.
According to Dan Greenhaus of Miller
Tabak & Co, "The Fed is on the verse of actively targeting a higher
inflation rate." This practice is untested. It can potentially backfire
if the inflation drifts further than the desired rate. In addition, it's not
clear at this point whether expectations related to inflation can drive real
and sustainable growth.
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Thank
you for reading.
Rosanne Lim
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