Thursday, February 18, 2010


Last night it was the news that the IMF was going to sell 191 tonnes of gold. Tonight it's the 25 basis point rate hike in the discount rate.

I'm going to let you in on a secret. Neither one of those things is going to materially affect the stock market or the gold market.

As a matter of fact over 75% of the time the market ends up higher by the third day after an initial hike in the discount rate. The Chicken Little's of the world see the sky falling but the reality is this has been a positive for markets almost 8 times out of 10.

Folks I'm going to let you in on a secret. The damage has already been done. The trillions of dollars the Fed has pumped into the market is not going to be withdrawn by a mere 25 basis point hike in the discount rate. By the way the discount rate is the rate the Fed charges banks to borrow. Very few banks even bother to borrow from the discount window. For all intents the rate hike today was basically the same as the Fed jawboning. All bark and no bite.

If the Fed really wanted to withdraw liquidity they would have to go on a massive treasury selling spree.  The problem is this would crash the bond market, spike rates, and drastically raise the cost of servicing our massive debt mountain. If the Fed were to do that, just the interest payments on our debt would soon sink the country. Not to mention it would still take months and months if not years to reverse the liquidity mess they created.

They didn't cram 12 trillion dollars into the market in one day and they certainly won't be able to withdraw it in a day.

The truth is there is no easy way out of this mess the Fed has gotten us into. I can tell you that human nature being what it is, I'm confident we will continue to kick the can down the road for as long as possible. So I wouldn't count on the Fed withdrawing liquidity anytime soon.

The reality is that the market is bouncing out of an intermediate and probably a yearly cycle low. Those kind of major cycle lows tend to produce the most powerful rallies. The average initial thrust out of an intermediate cycle low has been between 6% and 10% in 8 to 13 days. And that is just the initial thrust.

So far the market is behaving exactly as expected.

Don't forget we still don't have anything that looks like a daily cycle bottom on the dollar yet. This is what the markets have done in the face of a strong dollar. When the dollar decides to move into the daily cycle low we could literally see all markets explode higher still.

It's going to take a lot more than a mere 25 point hike, in a virtually meaningless interest rate, to derail the kind of powerful rally that happens out of a yearly cycle low.