FOCUS: Gold, Other Markets Uneasy On China, Ireland and Fed QE Program

(Kitco News) - Financial and commodity markets have been roiled in the past few days, hit by worries over a potential Chinese interest rate hike, an uncertain bailout of Irish banks and growing ideas the Federal Reserve won't buy as many securities as expected under its second quantitative easing program.

Markets across the board fell: the Dow Jones Industrial Average hit its lowest levels in about a month, gold prices sank and other commodities were bloodied. U.S. Treasury prices upticked slightly, but this came after two days of previous losses. The dollar rose as investors decided to flee risk. Whether this is a correction or a trend change remains to be seen.

For Wednesday, markets are off to a cautiously firmer start in general, with news that the European Union and the International Monetary Fund will come up with some sort of bailout for Ireland in coming days.

On Friday and Monday, to the surprise of many in the markets, U.S. Treasury yields inched up, and prices for those securities, because they move inversely, fell. This was not expected to happen after the announcement in early November of the Fed's $600 billion quantitative easing program which will buy Treasurys to push down yields in an effort to spur lending.

"There's been pressure from various sectors on the new QE from the Fed. If the Fed does less QE, less bond purchases, that means higher yields, and higher yields means lower prices," said Alan Bush, senior financial analyst at Archer Financial Services.

Bush was referring to the concerns some critics have that the second round of stimulus could cause inflation that would be difficult to contain. Along with complaints from countries like Brazil and China, several Republican lawmakers and economists penned an open letter on Nov. 15 to the Fed criticizing the move.

Bush said financial futures markets are currently predicting a 66% probability that the Fed will increase the fed funds rate by 25 basis points on or before its January 2012 meeting. Last week, financial futures markets were indicating the FOMC would not increase the fed funds target until late in the second half of 2012.

Dennis Gartman, editor of The Gartman Letter, said the dollar has risen as it has been the recipient of the idea "that QEII shall be a small boat rather than an ocean liner…. What buying there might have been has been destroyed and with margins being raised across a broad range of commodities, there is little wonder that prices have collapsed."

Kurt Kinker, chief market analyst at Mirus Futures, said the breaks in the commodity markets, precious metals included, came following swift rallies, so a retreat shouldn't be a surprise. "We had a lot of run -up pricing in QE2 and it was in line with expectations…. These markets are way overdone and a pullback is healthy. There's potential for more," he said.

Ever since Federal Reserve President Ben Bernanke floated the idea of a second quantitative easing in August, commodities and equities have rallied and Treasury yields have fallen. Kinker said prices had risen so much that even current breaks in prices are not near levels from late summer.

Kinker said it's difficult to say if the current reversals in commodities, Treasurys and equities are a trend change or just a correction. "It's hard to call it a trend change, but for some markets I think we've seen the highs put in for a long time. In Treasurys, I wouldn't be surprised if we've seen the all-time highs. If we took those highs out, then the U.S economic picture would have to be absolutely horrible," he said.

In addition to some growing ideas the Fed's easing program may not be as aggressive, the dollar found support over worries about Ireland, adding to the weight on commodities. Normally gold would benefit from financial worries, but the yellow metal didn't receive any obvious safe-haven buying as a result. Commerzbank said most of the recent selling in gold has come out of the futures. Part of that might be some market participant lightening up or exiting the market after the CME Group raised performance bonds needed to trade in those markets.

Kinker said gold prices could continue to weaken even after the recent losses and still not threaten the longer-term uptrend. "Gold could fall another $100 and still be in an uptrend. It may be healthy, too," he said.


Bush said there might be a second reason why Treasury yields have started to rise: the U.S. economy is growing.

"Stronger yields mean it could be a sign the economy is improving. We saw good retail sales and we're seeing improving signs in Asia. There's pressure there to raise rates in China. South Korea just raised rates. If the global economy is improving, people may be looking beyond the eurozone debt concerns. So (the Treasury yield rise means) less QE and a stronger economy," Bush said.

In the short term, markets can be lower because the easing has less stimulative effect. "But down the road it's good - stocks are up and there will be more demand for commodities," he said.

The potential for Chinese rate hikes remains a near-term bogeyman for commodities and "the largest challenge to global risk appetite" said BNP Paribas analysts.

With inflation at nearly a two-year high, speculation of a rate hike in the Asian nation is leaving gold and other commodity markets uneasy. "Although there is speculation of an interest rate hike in China as early as this Friday, the Chinese authorities appear to favor price control measures on 'important daily necessities.' The concern over tightening is having a serious impact on domestic sentiment," they said.

Janet Mirasola, managing director, R.J. O'Brien & Associates, said the combination of dollar strength and worries over Chinese tightening suggest that "commodities have become less desirable. " Still, she said: "continue to tread cautiously as the short term risk trade unravels but look for value in any fundamentally sound assets that may get oversold in the process."

By Debbie Carlson of Kitco News

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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