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Fed Rates vs. Gold & the Euro

For all his tough-talking, the Fed's Ben Bernanke needed Euro policymakers to raise rates and put a hole in Gold...

TWO MONTHS AGO in early June, writes Gary Dorsch of Global Money Trends, the Fed chairman Ben Bernanke warned that the US central bank was "working with the Treasury to carefully monitor developments in foreign exchange markets.

   "[We're] aware of the effect of the Dollar's decline on inflation and price expectations."

   Bernanke's subtle threat of stealth intervention in the currency markets came even though he never had any intention of lifting US interest rates to bolster the Dollar. Instead, it was the European Central Bank (ECB) that turned its tough words into action, hiking its repo rate to 4.25%.

   And yet the US Dollar, not the Euro, was the short-term winner from the lower oil prices that resulted. The price of Gold in both Euros and Dollars, along with pretty much everything else, was hammered.

   The Fed was successful in hoodwinking the gold bugs throughout July, sending false signals to the mainstream media about a tighter Fed policy – and a tighter policy sooner rather than later.

   On July 18th, with Gold trading near $960 per ounce, Minneapolis Fed chief Gary Stern warned that "headline inflation is clearly too high, and the Fed can not wait until financial and housing markets stabilize before raising interest rates."

   Then on July 22nd, Philadelphia Fed chief Charles Plosser warned that keeping monetary policy too loose for too long could worsen inflation by allowing expectations to get entrenched into consumer and business psychology.

   "To keep inflation expectations anchored means that monetary policymakers will have to back up their words with actions," he said. "We need to reverse course. I anticipate the reversal will need to be started sooner rather than later."

   Finally, on July 23rd, Plosser warned again that "real interest rates are negative, and we can't stay there indefinitely. We've got price pressures clearly throughout the economy. Ultimately, rates are going to have to go up."

   Talking tough, Stern and Plosser duped the gold bugs into a selling frenzy. Comes the Fed's next policy meeting on August 4th, however, the dynamic duo flip-flopped and voted to keep the Fed funds rate steady at 2% a full 3% and more below the rate of Consumer-Price inflation.

   The Fed's propaganda artists could hardly believe their good fortune. Gold and oil prices sank even as they signaled no change in negative US interest rates for the rest of this year.

   But as the charts better indicate, it was bottom-fishing in US financial shares – following the US government's explicit bailout of Fannie and Freddie – combined with sharply lower agricultural and oil energy futures, as well as a stronger Dollar, that were the chief culprits behind Gold's sharp plunge below $900 and onto $800 per ounce.

   It wasn't only Gold that got whacked by the ECB's rate hike on July 3rd. Copper prices tumbled 12% in the aftermath amid rising inventories on the London Metal Exchange and a slowdown in global factory activity.

   Stockpiles monitored by the LME jumped 22% since July 1st to 150,000 tons, and are the highest since February. The HSBC Global Mining Index fell 30% from its all-time high set in May, and the world's top 20 mining stocks lost $670 billion in market value over the 10 weeks to mid-August.

   But in the commodities markets, sentiment can turn instantly on a dime. Jesse Livermore, the early 20th century speculator, said the market is 90% emotional and 10% logical. It's difficult to catch a falling knife without getting hurt. But for long-term commodity bulls, the upcoming meeting on Sept 6th of the Opec oil cartel could mark a turning point from the current sharp falls in prices.

   "If there are expectations that demand will fall, or if supply is actually more than demand, Opec will act to balance supply and demand," said Qatari Oil Minister Abdullah al-Attiyah on August 1st. And beyond Opec, contrarians might see the dismal readings on global factory orders as nearing a bottom, pulling hard-asset prices out of this nosedive.

GARY DORSCH is editor of the Global Money Trends newsletter. He worked as chief financial futures analyst for three clearing firms on the trading floor of the Chicago Mercantile Exchange before moving to the US and foreign equities trading desk of Charles Schwab and Co.

There he traded across 45 different exchanges, including Australia, Canada, Japan, Hong Kong, the Eurozone, London, Toronto, South Africa, Mexico and New Zealand. With extensive experience of forex, US high grade and corporate junk bonds, foreign government bonds, gold stocks, ADRs, a wide range of US equities and options as well as Canadian oil trusts, he wrote from 2000 to Sept. '05 a weekly newsletter, Foreign Currency Trends, for Charles Schwab's Global Investment department.

See the full archive of Gary Dorsch.


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