All Eyes On The G20

The Fed was notably more dovish in its tone this week. On Wednesday, Fed Chair Powell warned of "generally elevated" asset prices. But then he followed that with: "The resulting drop in asset prices might be particularly large, given that valuations appear elevated relative to historical levels." We also got the headline: “Fed warns that a 'particularly large' plunge in market prices is possible if risks materialize.”

A market and economy used to low rates could face issues as the Fed continues to normalize policy through rate hikes and a reduction in its balance sheet, or portfolio of bonds it purchased to stimulate the economy. It added that “trade tensions, geopolitical uncertainty and a buildup in corporate debt among firms with weak balance sheets pose strong threats.” But the most significant headline was this comment:

*POWELL: NO PRESET POLICY PATH, RATES `JUST BELOW' NEUTRAL RANGE

Given that the range for the neutral rate, based on the Fed’s own dot plot, is 2.5-3.5% and the Fed Funds rate is currently at 2.25%, this was perceived to mean just one more rate hike of 25 basis points. Coupled with his other comments, this was seen as a recognition by the Fed of the risks to the stock market caused by their tightening policies and the U.S.-China trade dispute, and was the first hint that the Fed was considering pausing their program of rate hikes. All of which led to a spike in gold from 1217 to 1233.

Yesterday, we got the FOMC minutes for November, which were notably less dovish, in my opinion. The headlines were as follows:

Dovish

*FED MINUTES: POLICY NOT PRESET, UPSIDES AND DOWNSIDES WEIGHED

*FED DISCUSSED MODIFYING LANGUAGE ON `FURTHER GRADUAL' HIKES

Hawkish

*FED NOTED UPSIDE RISKS OF FISCAL STIMULUS, STRONG CONSUMERS

*ALMOST ALL FED OFFICIALS SAW RATE HIKE WARRANTED `FAIRLY SOON'

But the main headline was this one: “Only a COUPLE of participants believe Fed Funds is near Neutral.” This indicated that the market’s perception of just one more rate hike, based on Powell’s comment the day before, was wrong and that more rate hikes were needed to get to the neutral rate.

As for my take on all of this: Nothing has changed. I believe this is just a re-run of an oft-used policy by the Fed in such situations. The S&P Index has fallen 10% from its all-time highs. The Fed cannot hike into such equity market weakness. So it sends out multiple Fed members to talk dovishly, including Fed Chair Powell, in order to push stocks higher so that they can continue to hike. But when you look closely at their comments, nothing has changed. They still plan to gradually hike interest rates and reduce their balance sheet.

The other big event of the week, perhaps even more important for gold, is the G20 meeting today. It is no surprise that Gold has erased almost all of its gains ahead of this meeting—and the fact that we got nothing new from the Fed.

We’ve seen numerous headlines back and forth ahead of the G20, all of which should be ignored. The three basic scenarios for the outcome of this meeting are as follows:

The probabilities are mine. As you can see, I don’t foresee any substantive agreement between the U.S. and China. Both sides remain too entrenched in their positions. The most probable outcome is a temporary détente between the two, pending further negotiations which will likely lead to a temporary pop in gold and further upside in the S&P. But it will likely be short-lived, as have all positive headlines since this dispute began. Worst-case, all hell breaks out, S&P crashes, and gold dumps to lower lows. But the likelihood of this is low.

Should the meeting play out as the consensus expects and gold rises, 1250-55 is extremely strong resistance, with the 200-day moving average just above there at 1263. Failure to break these levels and down we go again. A sustained break above them would be very bullish, but until this trade dispute is resolved, it will be difficult for gold to get any traction on the upside.

My primary scenario for the bottom in gold and the massive rally to follow remains the same: A U.S. stock market crash followed by a Fed reversal in policy that causes the peak and fall in the dollar, including USD/CNY. Nothing from the Fed this week has convinced me that this is imminent, but I do believe that this scenario will play out in early 2019.

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