BNY Mellon: Gold and the Fed Put

31 jan 2019

By Simon Derrick, Chief Currency Strategist, BNY Mellon

• QE has proved a major driver of gold prices over past 18 years
• Fed policy has been a key factor in the past decade
• Price action over the last week is consistent with this

On March 19, 2001, the Bank of Japan (BoJ) made the historic decision to stop targeting the level of the overnight call rate and instead set the level of its current account as the operating target.

In practical terms the policy required the BoJ to purchase a range of financial securities in an operation known as "Rinban" in order to flood the financial system with excess liquidity.

The initial size of the "Rinban" operations was set at a relatively modest JPY 400bn and did little for sentiment. Even the decision on August 14, increasing the scale of the operations by 50%, appeared to have little real impact on markets.

However, a tipping point was reached in December of that year when the bank said that it would increase its operations by a further one-third, to JPY 800bn a month (while also increasing the amount available for short-term loans to companies and banks from JPY 6/JPY 9trn to JPY 15trn).

Unsurprisingly, this marked the exact point the multiyear uptrend for gold that had first emerged just weeks after the BoJ’s initial move began to gain real momentum (see chart below).

After a brief but dramatic setback during the global financial crisis in 2008, the introduction of QE programs by the FOMC and others supercharged the subsequent rally, taking gold from below USD 700 per oz to over USD 1900 per oz in just under three years. 

Although gold began sliding lower in October 2012, the major decline emerged post-April 10, 2013. This was the day it became clear that the Federal Reserve was preparing to taper its asset purchases.

By the end of that week, gold had fallen 6.7% against the USD while by the end of June it was down by almost a quarter. While prices did trend lower overall between the end of June 2013 and the end of December 2015, the lion’s share of the move had already taken place (see chart above).

Although it seems reasonable to assume that both the ECB and BoJ’s programs have likely played their part in recent years (although the JPY has behaved almost as if it is the equivalent of gold since Abenomics was first introduced), the evidence points to the Fed’s actions remaining the key driver.

The rally in February 2016, for example, came as the FOMC adopted a more cautious stance in the face of market turbulence.

Given this, it’s interesting to note the rally in gold prices that has been building as the Fed "put" has reemerged.

This has gained substantial momentum since last Friday when The Wall Street Journal reported that Fed officials are close to deciding they will maintain a larger portfolio of Treasury securities than they’d expected when they began shrinking those holdings two years ago. Unsurprisingly it has gained further ground overnight following Jay Poiwell's indications that “the case for raising rates has weakened somewhat” and the comments in the FOMC statement that not only is it willing to adjust its policy of winding down stimulus programme if the economy deteriorates but that it also wants to stick with a large balance sheet as it opts to maintain its current framework for setting interest rates.

With evidence also emerging that central bank gold buying has reached it's highest levels in nearly 50 years it is perhaps worth remembering that over this period the main trends in gold prices have tended to persist for very long periods of time.

What’s happening now could therefore prove the precursor to something of long-term significance.