Precious Metals Hit by the Evans’ Rule

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There seems to be a great deal of confusion about why gold (and silver) sold off in response to wednesday's announcement from the Fed.

gold futures
Source: Barchart

The Fed will be undertaking an even more aggressive expansionary policy than originally announced in September. Balance sheet will expand dramatically and so will the reserves and the monetary base. Treasuries sold off again today with higher inflation expectations (see discussion).

30y breakeven index
Dow Jones Credit Suisse 30-Year Inflation Breakeven Index (source: S&P)

So what's up with gold?

Clearly there is no single explanation. But the main thrust of the selling has to do with the introduction of the Evans’ Rule. Now that the end of this ultra-accommodative policy is linked to the unemployment rate, some gold investors are beginning to think the date is much closer than people had originally anticipated (as discussed here). The Fed has been known to be "behind the curve" and investors were betting the Fed will "overshoot" as usual (maintaining the policy of zero rates and extreme liquidity for much longer than necessary.) But with the Evans’ Rule in place, some funds involved in precious metals (including silver - silver March futures are down 3.5% today) think the exit is now much closer - simply because now the Fed will effectively be "forced" to exit based on their own rule.

Reuters: - Gold fell 1 percent on Thursday as fears the Federal Reserve might withdraw its economic stimulus if the job market improved dramatically prompted funds to reduce their bullish bets.

The metal fell below $1,700 on Thursday for the first time this week on economic worries about the U.S. "fiscal cliff," overshadowing its safe-haven appeal. Liquidation by large institutional investors in gold futures on fears of tax hikes in the new year also pressured prices, traders said. Silver dropped 3 percent for its biggest one-day decline in a month.

Gold's drop came a day after the U.S. central bank adopted numerical thresholds for its monetary policy. It said it would keep interest rates near zero until the U.S. unemployment rate fell to 6.5 percent.

Analysts said the move stirred fears that the U.S. central bank could put an end to its loose monetary policy which has boosted the metal's inflation-hedge appeal.

"With the economy showing some signs of recovery, we may see a 6.5 percent unemployment rate sooner than previously anticipated, so longer-dated funds that are heavily invested in metals are looking to reduce their gold positions," said Phillip Streible, senior commodities broker at futures brokerage R.J. O'Brien.

This effect is visible in the currency markets. The dollar index initially sold off after the treasury purchases announcement, but then recovered as soon as the Evans’ Rule was brought up. And dollar's stability is a negative for precious metals - even if inflation expectations are picking up steam again.

DXY futures
Dollar Index (DXY) futures (source: Barchart)

Source: Sober Look

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