Eric King:  “Tom, we will get to gold and the US dollar in just a minute, but first your thoughts in the aftermath of the Fed decision not to taper?”

Fitzpatrick:  “The whole of the market expectation, as guided by the Fed, was that we were going to see some tapering of some sort.  As we saw data deteriorate going into the Fed meeting everybody thought that they were going to reduce, but nobody was ready for the ‘non-move.’....

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“I think that if you look at the reaction afterwards, some of it was fairly logical.  We saw dollar weakness, and we’ve seen yields start to push their way lower.  But one of the things that now has people concerned is:  Despite the initial strong move in the equity markets, why have the equity markets performed so badly thereafter?

Our view is that by not doing anything, after having given this very strong guidance that they were in fact going to taper, what the Fed injected into the financial markets is a large degree of uncertainty.  And if there is one thing the equity markets dislike more than anything else, it’s uncertainty.  Therefore, the way you are seeing stocks trading at the moment is a reflection of that uncertainty which has now been injected into the market.”

Eric King:  “Tom, the US dollar broke to the downside after the Fed announcement.  Can you talk about the action in the dollar?”

Fitzpatrick:  “Yes.  We expected short-term weakness in the dollar prior to that meeting, and the Fed decision not to taper just reinforced that anticipated weak action.  But we have broken some important levels in terms of the Dollar Index.  Our sense is this weakness might go on for a little bit longer.  We don’t believe this is a change to the longer-term trend, where we expect the dollar to outperform most of the other fiat currencies.

But in the near-term, especially in the weeks ahead, and given the decision from the Fed, our view is that we will see continued weakness in the dollar through October.”

Eric King:  “Where does that leave us as far as the gold market, Tom?”

Tom Fitzpatrick:  “You know that we have always been of the view that the down-move in gold to the $1,180 area was the end of the much larger correction in gold.  But we are also watching the dynamics of the action in the equity markets.

We are looking at how gold performed during the stock market collapse during the 1973 - 1974 time frame.  Gold went up dramatically during that market collapse.  You can also track the next strong rally in gold very closely to the period when the subsequent market rally ran out of steam in 1976 (see chart below).

We have also overlaid things like the interest rate surge in the 1970s, the rising oil price, consumer confidence, etc., when looking at the dynamic price action in gold during the 1970s time period.”

King World News note:  On the chart above you can see the huge move in gold during the massive 1973 - 1974 bear market, as well as the subsequent explosion in gold beginning in 1976.  The chart below isolates just the 1976 - 1980 manic move in gold as stocks struggled.

Fitzpatrick continues: “All of this has led us to the conclusion that the equity market could really start to struggle in the September - October time period of this year.  It’s quite possible that the ‘put’ factor might be coming out of the equity market.  If this is correct and we do get this downside move that we expect in the general stock market, this would be a setup for conditions that would see the gold price trade significantly to the upside.

Circling back to the Fed, I think that at the end of the day they had an opportunity, they gave a guidance, and tapering was the right thing to do.  It’s our view that not only was it a mistake to give that level of guidance and then back away from it, but overall I think it’s going to be shown to be a mistake not to taper.

Increasingly this is delivering a bad message from the Fed.  The Fed told people that after QE1 they were bringing it to an end, and then they flipped.  They told people the same thing after QE2, and they flipped again.  After ‘Operation Twist’ it was the same message, but they flipped once again.

So the Fed habitually guides toward the idea of taking back some of the accommodation, the bond market reacts by plunging, rates go higher, and this has a negative feedback loop in the economy, and then the Fed chokes and fails to execute what they promised.  So the market reaction has helped to keep the Fed trapped and round and round the circle this has gone for the past 3 years.

I wouldn’t like to be the one going on record talking about the Fed losing credibility altogether, but I think without a shadow of a doubt if you look at the feedback following this latest decision not to taper, there are a lot of people who believe the Fed lost a lot of credibility with regard to how they have managed this process.”

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