In its last policy statement on the July 27, the Federal Reserve maintained a largely liberal tone in keeping its target interest rate between 0.25% and 0.50%. In it, the Fed expressed its willingness to look at more data before adjusting the target rate, so investors are now looking for the next set of clues that will determine the monetary policy route that is likely to unfold over the next few quarters. In terms of market reactions, a good deal of information can be gleaned from the performance of the SPDR Gold Trust ETF (GLD, Financial), which has seen rallies of nearly 30% over the last year.
This has come as something of a surprise to many traders and investors that might have assumed that the potential for higher interest rates from the Federal Reserve would be created declines in precious metals assets. The fact that this has not happened bodes well for additional rallies in GLD. But it will continue to be important for investors to understand which data the Federal Reserve is watching, as this could be the best indicator of trends in assets that are closely tied to generalized market sentiment. This is critical information for anyone that is looking to invest in stocks or commodities, as monetary policy could ultimately shape the supply and demand levels that will determine market valuations.
Unexpected Declines in Labor Markets
Next, we will look at the macroeconomic factors that are being most closely watched by the Fed in order to determine how precious metals markets are likely to trend over the long-term time horizons. In the current environment, market trends are likely to be influenced by some reports more than others but there are a few examples that will continue to be critical in guiding policy approaches.
Overall, the economic data released for August 2016 showed areas of temporary weakness. The non-farm payroll number showed an increase of just 151,000, holding far below the previous month’s 275,000 and still below the expectations of most in the market. The employment rate continues to strengthen in the service sector but figures remained muted in the manufacturing and mining industries. At the same time, the unemployment rate for August 2016 hold steady at 4.9%, which is actually same as the previous two months. These readings in non-farm payrolls and unemployment will likely limit any potential adjustments in the Fed’s target rate in the immediate future, and this is a factor that supports the outlook for gold and precious metals.
We also saw a rise in consumer prices to 0.8%, which is lower than previous six months readings (and below market expectations). The inflation rate remained muted because of further declines in energy prices and food inflation hitting a six-and-a-half year low. The efforts by the Fed to reach to its target inflation at 2% remain unrealized and this is another factor that will pressure the bank to avoid rate adjustments. Inflation is thought to have an inverse relationship with the price of gold, however, so the lackluster performance in consumer markets is a factor that could weigh on physical gold prices and valuations in GLD.
The second estimate of GDP as released by the Bureau of Economic Analysis reduced GDP estimates for the second quarter of 2016 to 1.1% (from previous estimates of 1.2%). As a point of comparison, the first quarter GDP was reported at 0.8% and the second quarter saw a rise to 1.1% (largely due to the rise in personal consumption). One of the biggest restraints to GDP growth has been institutional investment in the previous quarter, and the PMI (Purchasing Managers Index) data released for August reflects further concerns for the economy. This data could be most significant in terms of the ways it might impact sentiment in moves towards a flight to safety.
The US ISM report for the August fell to 49.4, the lowest level in past seven months and under the 50-level that separates expansion from contraction This is an often overlooked aspect of the economy, but one that is a good indicator of broader productivity levels. The report fell from the July reading of 52.6 largely due to contractions in new orders, production and employment. The index reflects many of the trends in the Business Confidence information, and a lower index means business owners feel that economy is declining.
Overall, the data released for August 2016, along with other international developments, does not support the possibility of rate adjustments at the Sept. 20-21 FOMC meeting. This would suggest short-term declines in the price of gold but when we look at the economic trends longer-term, weakness in growth numbers would point more to higher prices into the beginning of next year. GLD is still trading near its yearly highs, so further breaks higher from here could be strong if we see enough stop losses tripped to propel momentum.
Disclosure:The author has no active position in GLD.
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