Gold Flies As Fed Ramps Up Liquidity Efforts
Gold has been on an impressive run to the upside over the last two days. Since the Fed unveiled another huge stimulus package yesterday, spot gold has risen over $100, from beneath $1500 to around the $1600 region.
As a reminder, the Fed announced that it was prepared to purchase US treasuries and mortgage-backed securities without limit (i.e. unlimited QE) and unveiled various new programmes to add liquidity to the credit markets.
Why is gold loving all of this new stimulus from the Fed so much?
It largely comes down to one important factor.
Yes, gold is seen as a safe haven. But another key factor driving the performance of the precious metal is liquidity conditions in the market.
Let's rewind a few weeks, prior to when the Covid-19 outbreak went global. Gold hasd been performing very well over the past few months, with central bank easing and geopolitical concerns all acting as supportive. However, as soon as Covid-19 went global and markets panicked, Gold started to perform more poorly.
One of the main reasons behind this was that liquidity conditions began to tighten; i.e. investors begun to sell everything, risk assets (like stocks, crude and risk sensitive currencies such as AUD, NZD, CAD and EMFX) and havens (bonds, gold) alike wanting one thing - cash.
Such an environment (where investors are craving cash and there is a squeeze on liquidity) is a negative for gold. For this reason we saw gold fall from over $1700 to lows of around $1460 in the space of about a week earlier on this month.
Fed action has eased the liquidity squeeze
The Fed realised that there was a liquidity squeeze going on in the markets, pointing to a growing risk of a financial crisis. The
Stock, bond and credit markets were all coming under pressure - so the Fed has dropped rates to 0%, unveiled an unlimited QE programme.
USD funding markets came under pressure - so the Fed has massively stepped up its repo operations (offering $5 trln in funding over the course of just a few weeks).
The shortage of USD was putting huge pressure on international currency markets (as seen in USD’s huge appreciation) so the Fed, alongside global central banks, unveiled huge sums of USD swaps; where USDs are sold in exchange for foreign currencies to increase the supply of and weaken USD.
The Fed has also created a number of new programmes designed to lend money directly to the real economy (rather than through US banks), and will flood liquidity into the system that way.
For now, these actions appear to have worked. Stock, credit and bond markets have stabilised. USD is off of recent highs. USD funding market stress appears to have eased.
Gold’s latest rally serves as further evidence that recent shifts in Fed policy are working. Or, at the very least, Gold traders must now be more confident that the Fed has managed to avoid any imminent financial market/liquidity crisis.
What happens next remains to be seen. All will depend on how the Covid-19 crisis evolves, how the economy is affected and government and central banks respond.
During these uncertain times, we should take some positives and use this time wisely; let's continue to self-educate and be constructive. There are opportunities every day to extract money from the markets.
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