For Gold, The Fed’s Decision Didn’t Matter

THE FED’S DECISION

Pretty much everyone got it wrong.  Yes, they got the rate cut they were expecting; but as far as the price of gold is concerned, the Fed’s decision didn’t matter. The reason for this is that the focus on the Fed’s decision was misplaced.

It was a case of simple logic. But the logic was based on a faulty premise and led to unrealistic expectations.

Most assumed that a Fed rate cut would usher in a new round of easy money that would “drive gold prices higher”. That is where the breakdown in logic begins. And, it happens repeatedly.

The problem is in the assumptions that form the basis of a premise which then spawns the logical arguments for higher gold prices.

The one basic assumption that most people continue to get wrong is that they assume that gold is an investment; or at least an object of attention that changes value depending on various external circumstances and events.

The truth of the matter is in the following statements of fact: 1) Gold is not an investment. 2) Gold’s value is unchanging and constant. 3) Gold’s price does not respond to any of the factors that people consider to be “fundamentals for gold”.

The price of gold changes over time as a reflection of one thing only. That one thing is the value of the US dollar.

In this case people were focused on the Fed’s anticipated decision, rather than the US dollar.

Nothing in the action of the US dollar was indicative of most people’s highly exuberant expectations for the price of gold. Rather, the action of the US dollar seemed at cross purposes with those expectations.

Below is a one-year chart of the US Dollar Index and below that is a one-year chart of GLD over a similar period of time…

(bigcharts.marketwatch.com)

Over the course of the past year, the US dollar (as represented by DXY – the US Dollar Index) has continued to strengthen. There is a continuing succession of higher highs and higher lows. This is exactly the opposite of what one would expect, given the strength in gold’s price over the same one-year period. That strength is shown in the prices for GLD in the second chart.

If gold investors and analysts had cared to spend a bit more time focusing on the US dollar, rather than the Fed’s decision, they would not have seen any evidence that the US dollar was breaking down. This might have tempered their enthusiasm for higher gold prices.

The band wagon enthusiasm for higher gold prices was devoid of the only fundamental basis to expect higher gold prices – a weakening US dollar.

Even with the announcement of the Fed’s decision to “lower the target range for the federal funds rate”, the gold price turned around sharply and dropped as much as twenty dollars per ounce from its close the day before. And it may go lower still.

In fact, it likely will go lower; because the US dollar is strengthening, not weakening. And that is all that matters.