Why Does the Federal Reserve Have So Much Control over Gold?

The Federal Reserve’s monetary policies may not be directly tied to gold, but anytime a statement by the Fed is released, investors scramble to figure out what it means for gold. Because of this relationship, it’s vital to understand how gold tends to be affected by the Fed’s actions. Here is a look at gold through the lens of the Federal Reserve.

Quantitative Easing and Inflation

“Quantitative easing”, the “stimulus” and “monthly bond-buying program” are all terms used somewhat interchangeably to put a label on the Fed’s actions over the past 8 months. The monthly purchases of bonds and mortgage-backed securities to the tune of $85 dollars cause many investors to worry. Quantitative easing is not a simple process and there are serious inflationary risks that need to be mitigated during this undertaking. Traditionally, as inflation rises so does the value of gold. Simply put – quantitative easing is good news for gold, and the absence of it is bad news.

Talks of Tapering

In the middle of June of this year, Ben Bernanke announced a “tapering” of the stimulus would take place if the US economy continued to improve. Therefore, any hope of quantitative easing going away is fully contingent upon unemployment rates, the creation of new jobs, the housing market and other economic factors.

Mid-week Statement:

The notes from the Federal Reserve’s meeting in late July were released mid-week. The statement was rather uneventful as it did not address investors’ main concern as to when tapering would begin. The start of Wednesday saw an initial dip in prices and Thursday closed out the day on the positive overall. It seems gold reporters were looking for news that simply wasn’t there.

Friday’s Housing Data

Still looking for any clue that will shed some light on the tapering timetable, gold investors received good news today. New home sales fell 13% in July which was well beyond economists’ original projection of only a 2% drop. Again, because any tapering of the current US monetary policy is contingent upon positive data – this may mean the Fed will not begin lessening the bond-buying program until later this year or early next year. On the back of this news, gold jumped more than $20 per ounce within hours.

The Federal Reserve’s actions are so closely tied to the gold market that even speculation towards monetary policy can cause full percentage swings of gold prices overnight. Savvy investors would be wise to pay attention to September’s upcoming Federal Open Market Committee (FOMC) meeting. Unlike the meeting in late July, investors will not have to wait for notes to be released as September’s meeting will be accompanied by a press conference with Federal Reserve chairman Ben Bernanke.

Resources: Federal Reserve, Business Insider