Fed Minutes Suggest Fiscal Contraction. Gold and Silver Rally as Dollar Slides.

Today's Federal Reserve Meeting Minutes provided a more dovish stance on the economy. The sentiment now is that several Fed members are ready to act if conditions worsen. This is not as aggressive as some make it seem; the Fed made its forecast very clear, and the bank will continue to assess economic conditions. The Fed Minutes signaled out fiscal constraints, slower growth, and a 'normalized' Fed balance sheet as the three main problems. Taken as a hint of more easing and/or a prolonged recession, Gold and Silver rallied. The US Dollar sharply declined, despite the typical fake-out rally prior to the report - possibly from better home sales data (although lower than expected). European leaders also made it clear that Greece must stay in the Euro, which can be factored into the Euro's volatility to the upside.



For the most part, the Fed Minutes stated the obvious. However, when read closely, we get a better feel of how the Fed will calculate its coming decisions. The report cited problems such as the 8% July unemployment rate, accelerated long-term jobless numbers, and a slightly less deep recession. The recovery is a bit more gradual than expected. However, the report stated that the economy will perform moderately in the coming quarters, then a pick-up very gradually. Fiscal conditions pose as a continued threat to the speed of economic recovery in the US. Possibly referring to the 'fiscal cliff', in which tax increases could lead to a double-dip or prolonged recession.

The Fed stressed that we have a clear productivity problem as manufacturing production decelerated sharply. Lower demand and an inventory backlog due to a slowdown in Europe is adding to the strain. However, the US did see a slight pick-up in exports which helped to narrow the trade deficit. We should pay special attention to businesses decreasing their year-end economic outlook. Caterpillar posted record profits last month, but its CEO warned of a slowdown in the coming months. UPS decreased its outlook, citing a decrease in shipment demands and European woes. Lowe's stated that its home improvement sales are declining, and is shifting its strategy to lower priced goods online. Harley Davidson also reported lower forecasts. Big discount retailers such as WalMart and Amazon.com are experiencing rapid growth. With a decline in overall consumer spending and higher reported incomes, it's no wonder the US consumer is desperate for a discount. This is an indicator of tough times ahead.

The pick-up in housing sales needs to be analyzed further. Reports show that wealthy buyers and international investors seeking arbitrage are taking advantage of attractive home prices. Home builders such as Toll Brothers have increased their forecasts in response. Lower interest rates are fueling the 'housing recovery'. However, middle class homeowners are squeezed out. The Fed Minutes cited many middle class homeowners up to their heads in mortgage related debt. The better option being to step away from that long term amortized mortgage; with the home easily bought by a wealthy investor or flipped by the bank.

The Fed's clear forecast:

Treasury yields are declining on the longer 10 year end, in which the Fed cites the US safe haven appeal. Fed extending maturities through long term purchases should be factored in as well.

The Fed states that there will be a mid-2013 hold-out because of foreseeable fiscal constraints, then GDP will significantly exceed the growth rate of potential output. It is important to take heed of the "sharper than anticipated fiscal contraction" statement. With elections approaching, the government will experience poor conditions below the CBO baseline scenario no matter which administration is voted in. Bottom line: the first 6 months after election will be critical.

By 2014, the Fed expects that unemployment would remain well above estimates, with inflation at or below the 2% objective. This is the year in which Bernanke stated rates might break free of near zero territory. It looks like it might be a long time before a full recovery.

Update on my Silver buy recommendation:

SLV has approached the $27 support level, and today's rally added more fuel to help with a continued uptick. GLD was an obvious winner, with bearish US sentiment helping to force a rally. First Majestic (AG) is also speeding past its support level near $20. Although the fundamentals of year end troubles in the US call for an increase in GLD and SLV, the problems in Europe might overshadow this and stall upward movements. Daryl Montgomery posted an article on Seeking Alpha stating that gold and silver miners are setting up for a rally; more support for stocks like AG.