Once again we are approaching the end of a Fed stimulus and speculation is rampant about how the gold market will respond. Operation Twist – a rather poorly disguised repeat of quantitative easing – produced predictable results in stocks and treasuries, but its impact on the gold price was unusual.
Based on data provided by Eric Parnell in Seeking Alpha this chart shows the average monthly returns during each of the Fed’s stimulus programs and the intervals between:
Not surprisingly, stocks performed wonderfully when infused with mountains of free money. When stocks soar investors are drawn away from the perceived security of treasuries and those returns plummet. Conversely, when stimulus is withdrawn, stocks tumble and treasuries soar.
Gold, on the other hand, continued producing solid positive returns right up to Operation Twist, by which time its accumulated returns had surpassed those of both stocks and treasuries. Interestingly, Gold’s recent lackluster performance goes hand in hand with a significantly stronger drop in treasuries during this latest round of stimulus.
Although Operation Twist has a couple more months to run the results so far suggest that investors have acquired a stronger appetite for risk. That would be good news, except that nothing has occurred to improve the long-term economic outlook.
When the Fed terminated QE1 stocks plummeted as investors fled the market in search of safety. Five months later the Fed came to the rescue with QE2. The response to the end of QE2 was far greater than that to the end of QE1 and after just three months the Fed announced Operation Twist, a thinly disguised round three of quantitative easing.
There is every reason to expect that the end of Operation Twist will be even more profound. With a strong possibility of double-digit monthly declines in the stock market, the Fed will be under enormous pressure to swiftly introduce another round of stimulus.
It really doesn’t matter what the Fed does this time. Investors will have seen the wolf wearing sheep’s clothing. Freed from its restraints, the gold market will rush to make up lost ground.