Global Macro Monitor

The Fed expanding its balance sheet by over $1 trillion next year and the Bank of Japan expected to embark on massive quantitative easing and gold can’t catch a bid.  WTF?

Mark Dow over at Behavior Macro has the best ‘splaing we’ve seen.

Sentiment surrounding monetary policy has done a 180 over the past year or two. A couple of years ago it was very hard to make the case that QE wouldn’t be inflationary as long as the household sector was deleveraging, and that the market effects from it were predominately psychological. I still have the scars from those debates. Using technical jargon like ‘endogenous money supply’, in an attempt to recover some credibility, only got you more dismissive looks.

However, since then, markets have been (for the most part) coming around to this view, and consequently the half-life of a market reaction to the announcement of fresh monetary stimulus has fallen to about zero. This is new.

It has two implications. First, assets that have rallied from the flight into inflation hedges will continue to leak. It is not a coincidence, in my view, that the ‘evolution’ in the understanding monetary policy began right about the time gold and silver prices peaked last year. Ever since, the diminishing market impact of Fed announcements has become apparent to all, and the commodity complex has correspondingly stayed well below its 2011 highs. Yet virtually everyone is still calling for gold to make new all-time highs in the coming year.

From where I sit, many people have crowded into gold and silver (and oil—don’t even look at cotton!) on, inter alia, this flawed understanding of the monetary policy transmission mechanism and this will create selling pressure for quite some time. Will it be enough to offset the diversification demand from central banks and the income effect from the Chinese and Indian markets? This is a harder call, but I think the answer is yes—virtually certain if the recovery in the US gains traction and the Treasury curve steepens. It also bears recalling that central banks since the 80s have tended to be net sellers of gold when prices were low and net buyers when prices were high. So I wouldn’t count on central banks being there below the bid for too long if prices really start to drop. But it really is hard to say whether this will be a drip, drip, drip or something more sudden.

$1684 is a big number for cash gold.  Needs to hold.

(click here if chart is not observable)