Gold in the time of Monetary Stimulus

By FX Empire Analyst - Barry Norman
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The early morning release of the Chinese official PMI showed a declined to an 8-month low while the private HSBC PMI has improved slightly due to pro-growth measures. However, the PMI data from China reflects the weak factory activities and may support downside in today’s session as state backed enterprises remains the dominant force of industrial activity in the region.

At one end increased pro-growth measures and anticipation of further QE at FOMC is restricting downside while weak PMI releases and slowing economic activity may continue to further deteriorate metal prices at the other. From the eurozone, the German and UK PMI numbers are also likely to remain weak followed by lower ISM numbers from US and support downside in today’s session.

Although the only focus today will be the FOMC with their statement due later today followed by the ECB and the Bank of England tomorrow. These are the main attractions and all else is periphery information, which will most likely be placed aside as the Olympics take up the rest of the attention.

The US ADP employment may add jobs at a slower pace while construction spending may also remain weak on the back of lower demand for new homes and may restrict any gains in the evening hours. Overall, hopes of easing at FOMC may restrict much downside; however, the Fed stance may remain unchanged and may weaken base metals supported by weak PMI releases and economic development.

Keep in mind that once these main events are concluded, markets will not get a minute to breathe as we walk right into the US nonfarm payroll report on Friday.

Gold prices are underpinned by the awaited outcome of two day Fed-meeting. While market is banking on hope that Fed will commence additional easing measure today, we expect it to be just a pinch of direction. Bookmakers odds keep changing, it was 40% this meeting and 65% in the September meeting. Recent revisions show almost a 50% chance that the Fed will offer some sort of limited easing now and bring out the big guns in September.

Moving forward, gold is expected to remain pretty volatile as the rally was presumed on Fed stimulus. Traders expect the Fed may extend zero interest rate regime till 2015 replacing prior target of late 2014 and also there is possibility of a rate cut on excess reserve balance from 0.25% to 0.00% is an endeavor to start lending $1.5trillion of excess money laid with Fed.  With the Fed balance sheet swelled to $2.8trillion amid feeble economic growth of 1.5% with poor labor sector growth, the QE would expect to be at a diminishing return. As stated above, maybe not this time but the September 13 meeting seems to be more likely for QE-3. Although the reducing reserve rate is a kind of easing through more lending which may depreciate dollar and thereby bid the dollar denominated assets higher, heightened anticipation of growing QE-3 may signal sell-offs iff Fed disappoints once again.

The probability of the Fed refraining from QE-3 is high as discussed above. Germany again has strongly opposed for providing license to the ESM and so, the euro may again weaken pressuring gold prices.

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