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The Bullion Report

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January 26, 2011 in 'The Bullion Report'

The Fed & Precious MetalsThe Fed & Precious Metals

1-26-11

In a world dominated by trade in the US dollar, it would be unthinkable to divorce precious metals talk from the Federal Reserve. The Fed dictates monetary policy for the United States and obviously has a direct impact on the US dollar. The credit crisis and the subsequent fallout from the housing debacle have brought the central bank into the limelight like never before. Besides monetary policies for a reserve currency, what is the generally accepted relationship between the Fed and precious metals?

 

1-26-11 gc

Past performance is not indicative of future results.

***chart courtesy Gecko Software

First let’s address the main point most people will bring up – the US dollar is not backed by gold. The Federal Reserve’s own website makes it a point to mention that in their FAQ section. According to that page, “when the United States stopped selling gold to foreign official holders of dollars at the rate of $35 an ounce in 1971, it brought the gold exchange standard to an end. In 1973, the United States officially ended its adherence to the gold standard.” Gold and silver certificates can no longer be redeemed for physical metals at a Fed bank either.

The actual currency of the United States – the US dollar – is the important part of the relationship between the Fed and gold and other metals.

US dollars in circulation are mostly Federal Reserve notes. The central bank can buy securities from other banks and add more dollars to the system or it can sell securities to the banks and remove dollars from the system. At least eight times a year (sometimes more in times of crisis) the Federal Reserve meets and makes important decisions on monetary policy. They can have a profound effect on the US dollar. They can raise or lower interest rates, react to potential inflation or deflation, shimmy some statements around about recovery in times of recession or depression, and generally posture about economic conditions. The statements that follow these meetings bring obvious increases in market volatility.

If the Fed is timid in its language, as has been the case since the credit crisis started, then the dollar can suffer and gold can reap the benefits. Basically, any hedged views on the state of economic recovery can inspire more fear than faith in the condition of the United States. This fear often translates into an investor search for safe harbor. That harbor is often the gold market. Other comments that usually make precious metals the investment port of call include things like inflation concerns or a nod towards maintaining quantitative easing programs. The influx of dollars from stimulus usually means that the currency is being devalued, another practically surefire way to inspire people to exit the dollar.

On the other hand, buoyant speeches about the strength of recovery, an end to stimulus, or a firm grip on inflation targets are all potential killers for a gold rally or cues for profit taking.

Criticisms

The big one here is the extent to which the Federal Reserve can control or “manipulate” currency, thereby impacting the price of gold. There are plenty of arguments out there for ending the central bank system, and possibly returning to a gold standard. The caveat to this is that there may be an arguably paltry supply of gold in terms of potentially backing notes. Speaking of gold supply, there are also more than a few charges of a lack of auditing of physical gold holdings.

 The Federal Reserve has physical gold that it stores for other countries, as a kind of favor to them. It is in the New York branch that all this bullion lives. It is reportedly the largest gold repository in the world. In some of its recent reports, the Fed also holds over $11 billion in its own gold stocks. The issue some individuals and entities have is that they believe the deposits of gold are depleted beyond the levels reported, and that the Fed may actually ship the gold out of the US as it settles transactions. These concerns were expressed rather pointedly in a Gold Anti-Trust Action Committee ad in 2008. Is it true? Who knows, but it certainly fuels the calls for auditing. It also ignites other debates about central banks purposefully manipulating or even suppressing gold prices. Gold leasing programs from central banks are usually the central point in those arguments.

Summary

It may be hard to untangle the solid information from the growing number of concerns or allegations of manipulation or price suppression. One thing is evident – the actions of the Fed can either raise the US dollar’s international esteem or devalue it to the point of international criticism. In the recent case of the latter, this means that gold is seen as a haven. Precious metals become the spot to park wealth in an attempt to protect it from further devaluation. For this reason and this reason alone, it is worth keeping an eye on Fed actions and statements.

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“We've seen some progress in the financial markets, absolutely," Bernanke said. "But until we get that stabilized and working normally, we're not going to see recovery.” – FOX News article, 3-15-2009


Disclaimer: The prices of precious metals and physical commodities are unpredictable and volatile. There is a substantial degree of a risk of loss in all trading. Past performance is not indicative of future results.