The old saying on Wall Street is that you can’t fight the Fed. So see whether this is still true we plotted the changes in gold (GLD), the S&P 500 (SPY), and the monetary base back to 2004 on a logarithmic scale. Here are a few observations we drew from this chart:
1. The Fed does not always do exactly what it says. Case in point, in Sept. 2008 the monetary base breaks trend and jumps upward, implying Fed intervention. However this was months before the Fed would announce QE1 and a month before TARP. It appears that by Sept. 2008 the Fed knew the financial sector was near collapse and proactively began increasing the monetary base. We closely watch the economic data coming from the Fed to see what they are really doing and when they are doing it.
2. When a round of QE ends, the S&P 500 declines. This occurred in March 2010 at the end of QE1 and June 2011 at the end of QE2. When a new round of QE starts, the market rallies. We are closing watching Fed data to see when QE3 begins in earnest and would expect the market to tick up.
3. There is a 73% correlation between monthly changes in the monetary base and monthly changes in the price of gold. We trade gold using a model of economic indicators, of which the monetary base is one of the most important. An increasing monetary base is bullish for gold, and we will be watching closely for the impact of the Fed’s first round of QE3 on the monetary base.