Why Gold Loved the Fed's Taper-Holiday

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Yesterday, the stock market soared in response to the Federal Reserve's decision not to cut back on its bond purchases. The surprise move sent the Dow Jones Industrials (DJINDICES: ^DJI  ) up almost 150 points yesterday, although the market gave back some of its gains today. As of 12:15 p.m. EDT, the Dow is down 27 points.

But one market that hasn't given back any of its gains today is gold. The bullion-tracking SPDR Gold (NYSEMKT: GLD  ) is staying afloat this morning after soaring more than 4% yesterday, far outpacing the stock market. Gold now trades at about $1,365 per ounce.

Gold and the Fed's fundamentals
As a commodity, gold's price is largely defined by supply and demand. In recent years, investor demand has been a key component of gold's bull market, as exchange-traded products like SPDR Gold have made it easier for investors to get exposure to bullion.

Most gold bulls argue that the Fed's bond purchases have helped gold in two ways. First, by adding more cash to the financial system, the Fed encourages investors to buy assets of all types, including gold. Second, and more specific to the yellow metal, gold investors benefit greatly from low rates because gold doesn't generate income. When bonds pay more interest, owning gold involves greater opportunity cost for those who use cash on hand to buy it and incurs higher financing costs for those who borrow the money to purchase gold.

One primary contributor to gold's decline recently was fear that the Fed would encourage higher rates. That would reverse the tailwinds that have helped keep gold prices high and lead some investors to sell gold in favor of income-producing investments.

At the same time, though, supply has increasingly been a factor in gold prices. Low-cost mining companies Yamana Gold (NYSE: AUY  ) and Goldcorp (NYSE: GG  ) have seen their profits cut by the plunge in gold prices recently, but their profitability still isn't really at risk. By contrast, low gold prices have pushed some of the smaller mining companies that incur higher costs of production to the brink of closure as unprofitable conditions make long-term operations unsustainable at current prices.

That disparity is why smaller miners performed better yesterday, with Market Vectors Junior Gold posting an 11% gain compared to Market Vectors Gold Miners (NYSEMKT: GDX  ) and its 9% rise. Today, mining stocks are giving back some of those gains, with losses of 2% to 3% offsetting just a part of yesterday's profits.

One step back, two steps forward?
You can expect daily movements in gold in both directions for the foreseeable future, as fears will inevitably come back into the market. After all, the Fed's move is only temporary, and future decisions coming as soon as late October could restore investor anxiety about rising rates. Because of the emphasis on supply-demand dynamics and technical factors among gold traders, gold-investing experts are used to having to look closely at short-term concerns.

The key, though, is figuring out how to look past those short-term factors to keep a broader perspective. For instance, commodity guru Jim Rogers told Yahoo! Finance's Daily Ticker that he acknowledges that short-term factors could send gold sharply lower before it resumes its longer-term upward trend, and gold could fall below $1,000 before bouncing upward again. Yet he has high expectations for gold in the long run, arguing that repeated central-bank intervention has destabilized the currency markets, making gold's status as a hard currency more valuable.

Stay Golden, My Friends
Gold will continue to rise and fall in tandem with opinions about what the Fed's most likely next move will be. The best move for gold investors is to find ways to maximize their returns no matter which direction gold moves. The Motley Fool's new free report, "The Best Way to Play Gold Right Now," dissects the recent volatility and provides a guide for gold investing. Click here to read the full report today!


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