Unbiased Gold Analysis of Draghi Dropping the Bias / Commodities / Gold and Silver 2018

The ECB dropped its easing bias on Thursday. Monetaryhawks are pleased. But doves are holding tight. And what does gold do?

Hawks Awakenin Frankfurt…
A major change at the European Central Bank! OnThursday, it removed its long-standing pledge to increase bond buys if needed.In January we could read that statement:

(…) if theoutlook becomes less favourable, or if financial conditions become inconsistentwith further progress towards a sustained adjustment in the path of inflation,we stand ready to increase the asset purchase programme (APP) in terms of sizeand/or duration.

Now, it’s gone! What does it mean? The removal of thatpart of the monetary statement means thatthe ECB drops the explicit reference to the likelihood of an increase in thepace of purchases in the near future. In other words, the ECB abandoned its commitment to increase the size ofquantitative easing, if necessary. It implies that the bank has taken anotherstep away from its ultra-accommodative policy. It’s a hawkish change thatshould strengthen the euro further. The upward trend in the EUR/USD wouldsupport gold prices.

…but DovesDon’t Intend to Move Anywhere
Draghi pleased the hawks among the Governing Councilby dropping the ECB’s intention to increase bond purchases when the outlookworsens. However, the stimulus won’t end overnight. The ECB will remainaccommodative for a while. It moves at a very slow and gradual pace, in linewith its doctrine of patience. Draghi will continue its quantitativeeasing at least until September. And eventhen, interestrates will remain very low for at leastsix months after that. Indeed, the ECB executive board member Benoit Coeureclearly told the French radio station BFM Business on Monday that “it is veryclear to us that short term interest rates, the ones that are controlled by thecentral bank, will remain at very low levels, far beyond the horizon of ourasset purchases.” It means that the ECB will remain less hawkish than the Fed. Thisshould support the U.S. dollar, which would be bad for the gold market.

So, Who’sRight?
The ECB took hawkish action, but remains ultra-dovish.What is more important for the EUR/USD exchange rate and gold? Change, ofcourse. Investors think at the margin. States don’t count, only changes matter– unless they don’t, since they are too small to make a difference, or aresmaller than expected.

Let’s look at the chart below. As one can see, theeuro initially strengthened against the U.S. dollar in response to Draghi’scomments.

Chart 1: EUR/USD exchange rate over the last few days.

So at the beginning, investors interpreted Thursday’smove as a signal that the ECB is more certain about the economic outlook forthe Eurozone (the outlook for real GDP growth has been revised up for 2019)and, thus, it’s (slowly) preparing the exit from its quantitative easingprogram. However, after a while, the euro dropped like a stone.

What happened? Well, it seems that investors hadexpected that Draghi would be even more hawkish (after all, the interest rateswill remain low). And on Thursday Trump signed an order to impose tariffs onsteel and aluminum imports, which could affect the markets. The U.S. dollarcould strengthen as part of a “sell the rumor, buy the fact” strategy.

Implicationsfor Gold
The ECB’s removal of its easing bias is an importantstep towards the end of its crisis-era support. Surely, it’s a snail’s pace –but normalization is on track. Surely, it’s not revolution, but evolution. Butmarkets are forward-looking, so the ECB’s hawkish signals, if strong enough,should be fundamentally supportive for the gold market.

However, the ECB’s doesn’t act in a vacuum. Many other factors simultaneously  affect gold prices. Like Trump’s tariffs.Or the expectations of a Fed hike. The U.S. economy added 313,000 new jobs inFebruary, well above forecasts. As a result, the market odds of a March hike increased evenfurther and the price of gold fell. It suggests that gold may struggle in theshort term, in line with the pattern ofselling off ahead of the FOMCannouncements andrallying after them. Stay tuned!

Thank you.

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Arkadiusz Sieron
Sunshine Profits‘ MarketOverview Editor

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