Can The Gold Market Heal?

The U.S. Comex gold futures plunged 3.35% to $1,193.60 on Thursday after the Fed has announced a small tapering on Wednesday. This was the largest percentage decline since 26 June. In Shanghai on Friday, the gold futures slumped 2.2% to the lowest level since February 2010. Gold will likely end the year down over 25% from the end of 2012 while the developed countries equity markets have jumped 24%. The Dollar Index rallied 0.66% on Thursday to 80.63. In the past two days, the S&P 500 Index jumped 1.62% while the Euro Stoxx 50 Index surged 3.04%. The CRB Commodities Index rallied 0.63% while the gold futures fell 2.97% in the last two days. The U.S. 10-year government bond yield rose to around 2.93% on Thursday, a jump of almost 10bp in two days.

The U.S. Tapering Has Finally Started
With the Fed's balance sheet reaching $4 trillion as of last week, an improvement in the labour market and a reduced fiscal drag, the Fed will taper its asset purchases by $10 billion starting in January. The Fed is also expected to taper in steps of around $10 billion going forward. The benchmark interest rate will be held near zero even if the unemployment rate goes well below 6.5% provided inflation is below two percent. The Fed appears to be successful in using forward guidance to calm the markets and to convince investors that tapering is not equivalent to tightening. In fact, the Fed will roll over the maturing Treasuries and reinvest the principal payments of the mortgage debts. While the Fed's QE will likely end next year, the Bank of Japan will continue its annual QE of between 60 trillion to 70 trillion yen until Japan's inflation rate stabilizes at two percent.

Money Flowing to Equities
As investors tend to flock to winning trades, gold prices have suffered when equity prices in the major markets have rallied strongly partly because of the QE and partly because of the global economic recovery. Inflation in the U.S. is also moderate at 1.2% this year. As the Fed has made it clearer how the path of tapering will end, gold prices may well be pricing in quickly the end of the QE, hence the sharp fall in the price on Thursday.

What to Watch
Next week, we will monitor the November core PCE price index in the U.S. on 23 December, the U.S. November durable goods orders on 24 December as well as the November CPI and industrial production in Japan on 26 December.