Gold Consolidates Recent Corrective Activity

by Peter A. Grant

March 11, a.m.
(from USAGOLD.com) --

Gold is consolidating above the $1400.00 level after following oil and stocks lower on Thursday. Oil is under additional pressure this morning on reports that Japanese refineries have shut down after a massive earthquake shook the island nation earlier today. The yen initially sold-off on the quake news, but insurer hedging subsequently put a strong bid under the yen, which may limit the recent rise in the dollar.

Saudi Arabian security forces have been out en-mass today and thus far seem to have successfully prevented anti-government protesters from congregating and fulfilling their promise of a "day of rage." This has weighed on oil prices as well today, but there is still considerable pressure building on the Arabian Peninsula. Libya remains a hot-spot as well with recent gains by pro-Gaddafi forces resulting in increased calls for Western intervention and implementation of a no-fly zone.

Despite ongoing efforts to reign in inflation, China's February CPI came in at +4.9% in February. The market was expecting a slight contraction from the 4.9% rise in January. Given the recent vows to fight inflation in various speeches during the 11th National People's Congress, China will likely be obliged to further tighten monetary policy. "In this situation, interest-rate policy is definitely an important tool that needs to be used," said PBoC Governor Zhou Xiaochuan. Zhou also hinted that capital controls might be necessary to stem hot-money inflows that would be attracted by higher yields. See my commentary from earlier in the week.

As emerging economies continue to struggle with high rates of inflation, they are more regularly employing various forms of capital controls in efforts to prevent hot-money from exacerbating the problem. With the world awash in liquidity -- and seeking yield -- due to extraordinarily loose monetary policy primarily in the developed economies, the West has been accused of exporting inflation to the emerging world. Every time a country like China implements a capital control -- think of it as closing off a pressure valve -- the risk of asset bubbles developing in the West increases. Where might capital flow as barriers rise in high yielding emerging economies? Commodities and precious metals are likely to continue to prove attractive, which ends up translating into inflation as well. And when you're talking food and energy inflation specifically, it tends to have a much more devastating impact on emerging countries where consumers spend a larger portion of their income on necessities.

Having just past the two-year point of the equities bull market, stocks may become increasingly attractive as well. However, Thursday's 228.48 point plunge in the DJIA suggests the US stock market may be vulnerable amid investor fears that rising oil prices will derail the economic recovery. Additionally, the recent suggestion by Fed chairman Bernanke that the recovery is becoming "self-sustaining" would seemingly increase pressure on the Fed to remove accommodations. Of course there is a growing understanding that the 2-year stock market rally has been fueled by those very accommodations. An end to quantitative easing and higher rates risks undoing a significant portion of the recent equity gains, so I continue to expect the Fed to remain quite tentative about tighter policy.

The Fed reported that household wealth rose $2.1 trillion in Q4-10, driven by gains in the stock market. However, the value of real estate held by households fell $244 bln in Q4, on the back of a $629 bln drop in Q3. This, along with recent housing market data, are a very strong indication that residential real estate is indeed double-dipping and may well thwart the Fed's efforts to create a "wealth effect" that will drive the economy out of its malaise. If the stock market has put in a near term top and stagnates or corrects, I would anticipate Fed talk about QE3 to escalate early in Q2. If June rolls around and the Dow is 11,000 or lower, I would call QE3 all-but a sure thing. Further expansion of the Fed's already massive balance sheet, further debt monetization, is likely to drive the gold market higher.

Peter Grant is USAGOLD's resident economist and a well-known analyst globally in the forex and precious metals markets.

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