The One Asset That Is Vulnerable to Fed "Tapering"

The One Asset That Is Vulnerable to Fed "Tapering"

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

The anticipation is almost over, as the Federal Open Market Committee's September meeting gets underway today. However, we'll need to wait until tomorrow to find out the outcome of Fed policymakers' deliberations. Will they begin to pare back the central bank's monthly bond purchases? And if they do, by what amount? Those are the questions market participants of all stripes are mulling over.

Perhaps that cocktail of anticipation and reflection is keeping the market's natural propensity toward momentum in check this morning, as the S&P 500 and the narrower, price-weighted Dow Jones Industrial Average are up just 0.33% each as of 10:10 a.m. EDT.

More than stocks or bonds, gold looks vulnerable
Barring a curve ball from the Fed, I'm not expecting much of a reaction from the stock or bond markets at the outcome of the FOMC meeting. Gold, on the other hand -- whether in the physical market or in exchange-traded vehicles such as the SPDR Gold Shares -- certainly looks vulnerable if the Fed begins curtailing its quantitative-easing program, a.k.a. QE.

After all, goldbugs are convinced that QE has become a permanent feature of the financial landscape, necessary to propping up a bankrupt money system. Witnessing the Fed withdrawing its monetary largesse, rather than increasing it, ought to rattle that worldview (although goldbugs are nothing if not stubborn).

However, regardless of whether the Fed decides to taper QE this month, the next, or even early next year, I will repeat what I wrote last Friday:

The longer-term outlook for gold is not favorable. ... Although the Fed has said it does not expect to raise its policy rate until 2015, real interest rates will increase in the years to come. ... The benchmark 10-year bond yield has already shown it has that capacity this summer, and as rates normalize, they'll sound the death knell for gold -- and you can take that to the bank.

That view is consistent with the one articulated by Goldman Sachs' Damien Courvalin and Jeffrey Currie in a note published yesterday: "Our economists' outlook for accelerating U.S. growth late in the year (2013), clearly above-trend growth and a less accommodative monetary policy stance in 2014 remain the key driver to our bearish outlook for gold prices into 2014."

Indeed, interest rates will normalize as the Fed withdraws from the bond market and economic growth and growth expectations increase. Goldman expects gold to fall to $1,050 by the end of next year, but I think setting price targets on such a short time frame is nonsense; still, the longer-term trend ought to be clear. According to Bloomberg News, holdings in gold-backed exchange-traded products declined by 1.1 metric tons yesterday to 1,939.2 tons -- the lowest since May 2010. The average price of gold in that month was $1,205.43 per ounce.

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