Why Make A Trillion When We Could Make…Billions?

Taking into consideration the apparent calm that has settled over Europe’s financial skies in recent weeks, ECB President Mario Draghi served up a healthy dose of risk-taking treats to precious metals, oil, and euro-oriented bulls yesterday. By leaving the ECB’s key rate unchanged, Mr. Draghi did not imply that victory was at hand over the conditions that roiled Old World markets during most of 2012. 

Mr. Draghi also did not imply that regional economic conditions were suddenly rosy; au contraire, recent gauges of economic activity showed additional deterioration and only a modicum of stabilization trends. In one sense, Mr. Draghi took a page from the Fed’s policy playbook and indirectly said that his institution could/would act provided that conditions worsen –but only then. Otherwise, it is a case of status quo

You will recall that last week, at least two FOMC members who are regional Fed Presidents, expressed some reservations about continued loose Fed monetary policies. In light of the fact that the prices of certain assets such as bonds, agricultural land, and leveraged loans are in quasi-bubble territory, the Fed’s more hawkish voting members raised the specter that a prolonged period of zero-level interest rates might have not-so-welcome consequences not only now, but certainly down the road. 

What Mr. Draghi’s decision ultimately implied was the fact that a minor rate tweak at this juncture would not have done much to alter things. ECB watchers believe that Mr. Draghi may have also had one eye on the recent plunge in Spanish bond yields (to under 5%!) and thereby came to the conclusion that (at least) the bond vigilantes have been temporarily silenced by the prospect of the possible OMT program that was recently floated in EU/ECB summits. 

In any case, the result of the ECB non-maneuver became apparent in a hurry: the euro climbed 1.48% against the greenback while the latter lost 1.1% on the trade-weighted index (dropping to 79.74 yesterday afternoon). Crude oil moved 0.85% higher ( to a three-month high near $94) on the session as traders flocked to commodities as a group. 

The commodities’ asset class rose to its highest level in eleven weeks on the back of the ECB (non-) move. Our good friend George Gero of RBC Capital in New York characterized Thursday as a “good risk-on day.” We won’t disagree, but still find it disconcerting in an “old school” sense of things to have to lump gold into the “risky” asset basket. 

The dollar’s losses also translated into a finally better day in the precious metals’ complex. Gold gained over 1.1% on the session and reached a high of $1,680 before settling at $1,000 per ounce in New York’s spot market. Gold’s Thursday performance was also aided by news that China recorded a 14.1% jump in December exports. 

Also probably playing into gold’s strength was the fact reported rush among Indian gold  traders to load up on (now much cheaper than in early December) gold ahead of a possible hike in import taxes to 6%. It was estimated but not confirmed that this proactive purchasing spree may have resulted in the placing of orders of up to 25 or 30 tonnes of bullion last week. As a result of such a putative spike in imports, India’s government officials might now think twice before they leak stories about considering tax hikes instead of just decreeing them. 

At any rate, the alleged buying spree among importers has been a story that was somewhat tempered this morning by India’s Economic Times. The publication reports that albeit local prices for gold were at their lowest in a week, they were not enticing enough for importers to book orders. “There are a few stray deals. People are not interested in stocking up at these levels as prices are in the same range since three-four days," said a dealer with a private bullion importing bank.  "There was an initial interest in the market after rumours of import tax, but after a few days buying fizzled," the dealer added. To buy or not to buy – ahead of a mini wedding/festival season? That is the question in India currently. 

When it comes to a different set of question about gold, Marketwatch contributor and Pension Partners portfolio manager Michael Gayed opines that gold is facing a dilemma as this year gets started. The yellow metal’s recent behavior (trading much like a risk asset, reacting more to deflation than to inflation, ignoring geopolitics, etc.) suggest that investors may be concluding that equities are a better asset of choice when it comes to inflation-hedging (not that we have manifest inflation to seriously hedge against). 

Mr. Gayed notes that “One of the reasons many invest in gold is because supply is set and cannot be expanded. Against the backdrop of stock supply, which is shrinking, however, that particular reason for holding gold becomes an even stronger reason to own equities as a result of the share-buyback trend. Because investments must compete for dollars, this could explain why money has preferred stocks to gold under risk-on/reflationary periods.” 

When it comes to “risk-off” periods of turbulence, Mr. Gayed simply points to the chart of the ratio between the GLD ETF and the S&P 500 (SPY). He notes that the aforementioned ratio has been in a decline since mid-November as well as throughout the fiscal cliff countdown period. The ratio recently broke a key support level-one that was in place for about two years (see below). He also opines that the ratio might ultimately fall to the May 2010 level  (roughly one-to-one). Mr. Gayed’s Accelerated Time and Capital models continue to indicate that gold is difficult to time in a situation where former tailwinds are suddenly becoming headwinds. Herewith, a graphical representation of the GLD/S&P ratio and its relatively recent “evolution” towards parity: 


In addition, gold may also be factoring in the specter of soon-to-rise interest rates and the corresponding re-allocation out of bonds in an environment of (slowly?) rising real interest rates. The Fed’s recent meeting minutes are cited as evidence of such a paradigm shift becoming a possibility –even before the calendar turns to 2014’s first date. 

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