Effect on Gold of Fed Rate Cuts or Non-Cuts?

[raja]

Any guesses as to what will happen to gold after the Sept. 18th Fed meeting in which they will decide whether to cut the discount rate . . . or not?

EJ posted, ". . . the (recent) breakout (in gold) is likely a bet that the ECB rate hike hold announcement yesterday presages a Fed cut Sept. 18, despite high inflation expectations. Gold may fall on the fact of a cut."

Could someone help me understand this?
If investors expect a rate cut, then they would be hoping for a loosening of credit and rising equities, right? So why would expectation of a cut boost investment in gold?
(If a cut actually occurs, I can understand why gold probably would go, down because investors will put their money back in equities.)

In searching around the web, I tried to find other opinions and evidence one way or the other. Here are two that seem to contradict the above:

"The Fed lowering rates will reinforce bond-market perceptions of hostile Fed intent to savers and lead to lower yields on short-term US Treasuries. Thus any Fed cutting action, just as in the early 2000s, will drive real rates lower and eventually negative. So it looks like we are now on the verge of another very low or negative real-rate episode in the US. Of course this will be very bullish for gold."

and . . . .

"The bottom line is prevailing US rates of return after inflation are low today and will probably go negative again soon. During such episodes in history, gold tends to really thrive. Debt investors, tired of trivial gains or actual losses of purchasing power in return for lending their capital, join in the gold rush to preserve their capital through financial-market conditions openly hostile to savers."

Here's another interesting perspective on rate cuts:

"While the Fed likes to believe it sets interest rates, in reality it usually closely follows what is already happening in the short-term debt markets. When market forces drive short-term Treasury yields lower on their own accord, the Fed is generally forced to follow by lowering its own rates."

Any thoughts are appreciated . . . .

[jk]

i've been asking myself the same questions. the most common analysis is that when the fed cuts, investors will see the printing presses running and try to preserve wealth by buying gold. so people front-run that scenario.

so one thought is that this will be a buy on the rumor, sell on the news event. everyone who is paying attention to gold buys in anticipation of the cut. when the cut arrives there is little further appreciation and traders take profits, dropping the price.

another analysis might depend on the size of the cut:
no cut- equites and gold both drop a bunch
25bp - equities and gold, disappointed, drop a little or go sideways
50bp- equities and gold both rally a bit
75bp- a. equities and gold both have a party
75bp- b. people think the fed must really be scared and deflation is around the corner, and both equities and gold drop hard.
75bp- c. equities drop on the negative economic news implicit in the cut, gold rallies on the assumption of attempted inflationary bailout.

you can make up scenarios and explanations galore, in the comfort of your own home!

whatever happens, though, it will all look inevitable in retrospect.

for myself, i find it more useful to think in longer timeframes.

[c1ue]

Rate cut less than expectations (0 or 25 bp): Stocks tank, gold drops but less. I would say stocks and gold would move in tandem, but I am seeing more and more evidence that there are large chunks of money moving into gold and do not believe it is all short term speculative.

Rate cut equal to expectations (50 bp): gold drops a bit as short termers take profits, stocks rally for 1 day - max 1 week - then resume downward march. This is unless somehow housing turns around.

Rate cut beyond expectations (75 bp): gold increases somewhat, stocks rally more strongly but resume downward movement after 3 weeks.

A lot will depend on the language the Fed uses; even a 50 bp cut without a clear signal of further easing will yield an effect more like the "less than expectations" scenario. Similarly a small cut but with a strong bias will yield a stronger scenario.

So you see I don't actually see gold doing all that well in the short term - overbought. But since I don't actually know and already own it - I'm just moving my stops with a fairly tight range.

Strategy would be much different (and difficult) if I was looking to open a position.

[Finster]

There are two elements relevant to the price of gold that we have a pretty good handle on. Some discussion of UST in general and the yield curve in particular is germane here. It looks like we are getting a steepening trade. The first chart below represents the excess of the ten year yield over the one year yield.

The other one is the price of gold in relation to other commodities. The second chart below is a weekly chart of the ratio of gold to the DJ-AIG Spot Commodity index.

Both charts cover the period from Y2K to last weeks' close.

Putting these two together, do we see anything significant? The last time the yield curve steepened we saw a pretty healthy runup in the gold to commodities ratio. And this on top of a pretty healthy runup in commodities to begin with.

http://users.zoominternet.net/~fwuthering/Posts/TNXTOX20070908.png

http://users.zoominternet.net/~fwuthering/Posts/AUXDJC20070908.png