Gold Price Tumbles, Chinese Data, Fed Spook Wall Street

GOLD PRICE NEWS – The gold price tumbled $45.91, or 2.6%, to $1,736.44 Thursday amid significant weakness in financial markets across the globe.  Silver plunged alongside the price of gold, by $2.61, or 6.6%, to $37.01 per ounce.  U.S. markets were set to open with large losses, as S&P 500 futures dropped 30.00 points to 1,125.75.  In addition to disappointment stemming from yesterday’s Fed meeting, a weaker than expected report on the Chinese economy helped fuel the selling.  HSBC’s preliminary China Manufacturing Purchasing Managers’ Index, or “flash” PMI, slid to a two-month low of 49.2 in September, below the 50 level separating expansion from contraction.

On Wednesday the gold price turned sharply lower while the U.S. dollar rallied after the Federal Reserve announced plans to launch Operation Twist.  The spot price of gold climbed to as high as $1,817.80, but subsequently tumbled to an intra-day low of $1,778.00 following the Federal Open Market Committee (FOMC) announcement.  Silver followed the gold price lower, from $40.76 to $39.84 per ounce.  The U.S. Dollar Index (DXY) advanced 1.0% to 77.78, while the euro sunk 1.0% to 1.3570.

Gold equities headed south alongside the price of gold yesterday afternoon.  The AMEX Gold Bugs Index (HUI), which had been higher by as much as 2.1%, finished with a loss of 1.8% at 611.33.  Three of the HUI’s largest decliners were Kinross Gold (KGC), Newmont Mining (NEM), and Randgold Resources (GOLD) – which fell 3.4%, 3.2%, and 2.9%, respectively.

The broader markets tumbled as well following the Fed meeting.  Widespread liquidation engulfed Wall Street, as the Dow Jones Industrial Average (DJIA) plummeted 283.82 points, or 2.5%, to 11,124.84.  The CBOE Volatility Index (VIX), a closely-followed measure of investor risk aversion, surged 12.1% to 36.83.  Cyclical commodities retreated, with oil declining 2.5% to $84.77 per barrel and copper off by 1.8% at $2.70 per pound.

The gold price and other dollar-denominated asset classes posted steep losses after the Ben Bernanke-led Fed chose to extend the average maturity of its holdings of U.S. Treasuries, also known as Operation Twist.  Under the terms of the plan, by June 2012 the Fed will purchase $400 billion in Treasuries with remaining maturities of 6-30 years and will sell an equal amount of Treasuries with remaining maturities of no more than 3 years.  The primary goal of Operation Twist is to further reduce longer-term interest rates in the hopes of more effectively stimulating the economy – particularly the housing market.

Other noteworthy items from the Fed announcement included the addition of the word “significant” to “downside risks to the economic outlook.”  In addition, the Fed chose not to lower interest on excess bank reserves – another easing measure that many economists expected Bernanke to consider.  The central bank also chose to begin reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities in order to “help support conditions in mortgage markets.”  In the same fashion as the August FOMC, the Fed’s easing measures were met with three dissenting votes – from Presidents Fisher, Plosser, and Kocherlakota –” who did not support additional policy accommodation at this time.”

Commenting on the FOMC meeting, Goldman Sachs chief U.S. economist Jan Hatzius wrote in a note to clients that although the Fed did not lower the rate on excess reserves – as Hatzius had forecasted – “the details of today’s action were more aggressive than expected.”

“First, a relatively large portion of the purchases will occur at the long end (29% in the 20-30 year maturity bucket), implying a total impact of more than $400bn in 10-year equivalents, versus market expectations of perhaps $300-350bn,” Hatzius added.  ”Second, the Fed will reinvest maturing and prepaid agency MBS and agency debt in agency MBS, rather than Treasuries, suggesting a bit more support for the housing sector. The statement retained an easing bias, noting again that the FOMC ‘is prepared to employ its tools’ to ‘promote a stronger economic recovery in a context of price stability’.”

While the Goldman economist did not comment on the implications of the Fed meeting for the gold price or any other sectors of the financial markets, the announcement’s easing bias would suggest support for dollar-denominated assets.  However, the markets’ reaction far from illustrated that on Wednesday, as investors were disappointed that the Fed did not go far enough with its accommodative measures.

In the aftermath of the Fed meeting, although the gold price may face additional headwinds in the short-term, the longer-term outlook for the price of gold remains more favorable.  Chairman Bernanke has made it particularly clear that his foremost goal is to prevent deflation from overwhelming the U.S. economy and that he is willing to go to extraordinary measures to fight that battle.  The inclusion of the “significant,” wording – coupled with the commitment to “employ its tools as appropriate,” and leave the Fed funds rate near zero through mid-2013 – suggest that the Fed is likely to maintain policies that indirectly benefit the gold price for the foreseeable future.