Gold: The Fed Wrought Havoc On Precious Metals

Gold declined on Thursday, or I should say, gold rushed down at breakneck speed. And while it might have been a surprise for some, it wasn’t for me. However, we should stay alert to any possible changes, as no market moves in a straight line. Tread carefully.

On a side note, while I didn’t check it myself (it’s impossible to read every article out there), based on the correspondence I've received, it appears I’ve been one of the only authors to actually be bearish on gold before the start of this week.

Please keep that in mind, along with me saying that yesterday’s decline is just the beginning, even though a short-term correction might start soon. Having that in mind, let’s discuss what the Fed did (and what it didn’t do) in greater detail.

Look At What You Did

With the U.S. Federal Reserve’s reverse-repo nightmare frightening the liquidity out of the system, I highlighted on June 17 that the Fed raised the interest rate on excess reserves (IOER) from 0.10% to 0.15%.

I wrote:

"The Fed hopes that by offering a higher interest rate it will deter counterparties from participating in the reverse repo transactions. However, whether it will or whether it won’t is not important. The headline is that the Fed is draining liquidity from the system, and increasing the IOER is another sign that the U.S. federal funds rate could soon seek higher ground.

"Please see below:

"To explain, the red line above tracks the U.S. federal funds rate, while the green line above tracks the IOER. If you analyze the behavior, you can see that the two have a rather close connection. And while we don’t expect the Fed to raise interest rates anytime soon, officials’ words, actions, and the macroeconomic data signal that the taper is likely coming in September."

And in an ironic twist, while the question of whether it will or whether it won’t seemed reasonable at the time, the tsunami of reverse repurchase agreements on June 17 signal that 0.15% just isn’t going to cut it.

Case in point: while the Fed hoped that the five-basis-point olive branch would calm institutions’ nerves, a record $756 billion in excess liquidity was shipped to the Fed on June 17. For context, it was nearly $235 billion more than the daily amount recorded on June 16. Please see below:

To explain the significance, I wrote previously:

"A reverse repurchase agreement (repo) occurs when an institution offloads cash to the Fed in exchange for a Treasury security (on an overnight or short-term basis). And with U.S. financial institutions currently flooded with excess liquidity, they’re shipping cash to the Fed at an alarming rate.

"The green line above tracks the daily reverse repo transactions executed by the Fed, while the red line above tracks the U.S. federal funds rate. Moreover, notice what happened the last time reverse repos moved above 400 billion?

"If you focus your attention on the red line, you can see that after the $400 billion level was breached in December 2015, the Fed’s rate-hike cycle began. Thus, with current inflation dwarfing 2015 levels and U.S. banks practically throwing cash at the Fed, is this time really different?"

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