There is an ongoing debate among market participants over the reasons for asset elevation - global growth expectations? liquidity hose-pipes? European tail-risk reductions? or some combination of the three. Citi's Steven Englander attempts to uncover the changing face of the Fed's QE impact - with some very specific findings this time around.
Citi, QE3: Less Flavor, More Calories
Ever since QE3 expectations solidified in mid-August gold has far outperformed the S&P and risk-correlated, in contrast to when QE1 and QE2 were announced. We see this is indicating that the expected impact of QE on activity is less for this round than for previous rounds and that the attractiveness of the rest of the world is also less than when the prior QE rounds were announced.
We look at the gold reaction as a an indication of how much asset prices are driven by pure liquidity addition, the S&P to see how much is expectation of top line growth (recognizing that liquidity also has some impact) and risk correlated G10 currencies (a basket of CAD, AUD,NZD, NOK, SEK) as a measure is how much the impact is pure substitution out of USD.
When QE was announced in March 2009, the gold price reaction was relatively muted throughout the period, S&P exploded from the get go and small risk sensitive G10 currencies traded in between (Figure 1).
Figure 1. Gold (light blue), S&P (navy) and small G10 currencies (green) indexed to 100 when QE1 announced
We date the second QE from late August 2010 when Fed Chairman Bernanke gave his 2010 Jackson Hole speech. Again the S&P reacted sharply, although the runup in the first six months of QE2 was less than in the first six months of QE1 (Figure 2), Currencies and gold held their own but the dominance of the equity market impact is clear.
This episode shows very different behavior so far. Recognizing that it is early days, what is clear is that the gold response is far outpacing the S&P and currency move (Figure 3). Gold is by far the winning asset relative to the S&P and even currencies. This is consistent with a view that there will be a lot of liquidity in the system but that neither US nor global prospects are as attractive as they were in the past. Hence the appeal of gold as an asset that reflects high liquidity and is a near money substitute.
Figure 3. Gold (light blue), S&P (navy) and small G10 currencies (green) indexed to 100 in most recent QE episode