A “sterilized” form of QE is unlikely to have a significant impact on the price of gold

The gold price advanced $10.86, or 0.6%, to $1,696.05 per ounce Thursday morning amid U.S. dollar weakness and a disappointing report on the U.S. labor market.  The price of gold climbed to as high as $1,704 in overnight trading while the U.S. Dollar Index slid 0.4% to 79.370.  Weekly jobless claims came in at 362,000 – above the 352,000 consensus estimate among economists.  U.S. equity markets shrugged off the data, however, as the Dow Jones Industrial Average (DJIA) rose 0.6% to 12,907.90.

Yesterday’s gold price strength was driven by a report from the Wall Street Journal that the Federal Reserve is contemplating alternative methods of monetary policy easing.  As opposed to its traditional quantitative easing (QE) measures, the WSJ reported that “The Fed could print money to buy long-term bonds, but restrict how investors and banks use that money by employing new market tools they have designed to better manage cash sloshing around in the financial system. This is known as ‘sterilized’ QE.”

The WSJ went on to say that “The Fed would print new money to buy long-term mortgage or Treasury bonds but effectively tie up that money by borrowing it back for short periods at low rates. The aim of such an approach would be to relieve anxieties that money printing could fuel inflation later, a fear widely expressed by critics of the Fed’s previous efforts to aid the recovery.”

As for the gold price, the implications of the proposed Fed measures are quite clear.  If, as the aforementioned strategists suggest, the Fed is seeking to provide greater stimulus and launch a third round of money printing, the yellow metal is likely to benefit.  Alternatively, if the Fed is merely looking to alter the components of its balance sheet, a “sterilized” form of QE is unlikely to have a significant impact on the price of gold.

200 DMA to be a critical level indicative of the bullish or bearish trend in the price of gold

The gold price hovered near $1,675 per ounce Wednesday morning after the latest report on the U.S. labor market largely met expectations.  The price of gold showed a muted reaction to the February ADP Employment report, which at 216,000 was fractionally above the 215,000 consensus estimate among economists.  Silver stabilized alongside the gold price after the jobs data was released, near $32.95 per ounce.

Jonathan Jossen, a gold options trader at the COMEX, stated in comments to Reuters that “People who are long gold are getting out. They don’t like what’s going on with Greece and the stock market is decisively lower. It’s a matter of raising money.”

Analysts at Commerzbank wrote in a note to clients that “There is still a correlation between gold and risky assets such as equities and industrial commodities.  This is probably due to investors with a short-term horizon selling long positions on the futures market.” At its current level, the gold price is now sitting right on its 200-day moving average (DMA) of $1,673.98 per ounce.   Many traders consider the 200 DMA to be a critical level indicative of the bullish or bearish trend in the price of gold.  Yesterday, several traders contended that if the gold price falls decisively below its 200 DMA, further selling could materialize.
While such a technical perspective may be widely followed, history suggests that it does not work well as a timing indicator by which to invest.  During the ongoing 11-year gold bull market, the gold price has dropped under its 200 DMA on numerous occasions– including in 2003, 2004, 2005, 2006, 2008, 2009, 2011, and earlier this year.

Although calls arose each time for the end of the bull market, every instance marked an important bottom in the price of gold.  Moreover, during the corrections the gold price declined on average only 3.7% below its 200 DMA.  While the latest challenging period for the gold price could persist, the evidence therefore indicates that the weakness is meant to be bought rather than sold.

Physical demand wanes above $1,750

With gold falling from just below $1,790 to as low as $1,689 at one stage late yesterday, we look at the behaviour of the physical market over the past 4 months to determine what the potential behaviour might be. More specifically, we look at our Standard Bank Gold Physical Flow Index (GPFI). Our GPFI tracks actual physical gold flows that Standard Bank sees — much of these flows are into Asia and India. An index
value below zero indicates the physical market is a net seller, while a value above zero indicates the physical market is a net buyer. The greater the index value (in absolute terms), the stronger the buying/selling forces.

The behaviour of the physical market does indicate that this segment is price-sensitive. The general trend is fairly consistent: when the gold price moves lower, physical demand rises. When the gold price rises, physical demand falls away. Back in November, when seasonal demand was strong, we saw physical demand push higher after gold declined from $1,800 to $1,700. Demand grew even stronger in mid- December after the drop below $1,500. However, with seasonal demand waning towards the end of January, a gold price
above $1,700 since the start of February has seen a steady decline in physical demand (as is evident in the steady decline in our GPFI index).

We note that the physical market adapts to higher prices over time, i.e. levels that were seen as too high a few months ago, are now seen as good buying opportunities. That implies that where this segment of the market saw gold above $1,700 as too expensive, these expectations may adapt, and this level may be seen as a buying opportunity. However, we also note that February to June is typically a period where physical demand
is weak (relative to the rest of the year). As a result, we believe that there may only be really strong support closer to $1,650.

Gold price may rebound as the Fed reconsiders the possibility of QE3

The gold price held near $1,700 per ounce Monday morning as financial markets digested a lower Chinese economic growth forecast.  The price of gold traded in a wide range between $1,695 and $1,720 in overnight trading after China reduced its growth target for 2012 to 7.5% from 8.0%.  The U.S. dollar stabilized near unchanged against a basket of foreign currencies, while equity markets turned modestly lower in morning trading.

Last week’s entire decline in the gold price occurred on Wednesday, when the yellow metal plummeted $92.00 following congressional testimony from Fed Chairman Ben Bernanke.  The tone of Bernanke’s remarks was less dovish than expected, and he indicated that the Fed does not intend to launch a third round of quantitative easing (QE3) in the near future.

Dennis Gartman – author of the widely-read Gartman Letter – commented that “When Bernanke didn’t mention the possibility of another round of monetization, that was enough to take the fizz out of everything.  Before today, gold was looking quite strong, but today it just gave up the ghost.” A key reason for Bernanke’s less dovish stance was the Federal Reserve’s improved outlook for the U.S. economy.  In his prepared testimony, the Fed Chairman stated that “With output growth in 2012 projected to remain close to its longer-run trend, participants did not anticipate further substantial declines in the unemployment rate over the course of this year.”

While the Fed is projecting continued improvement in the labor market, it is critical to note that its economic forecasts have historically been overly optimistic.  Two of its most noteworthy mistakes included missing the bursting of the housing bubble, and later the severity of the 2008 financial crisis. Looking ahead, the Federal Reserve’s outlook will be tested in short order as the February non-farm payrolls report will be published on Friday.  The monthly jobs data will be one of several economic data points and catalysts for the gold price that is released in the coming week.  Monday’s schedule includes the ISM Services Index and a report on Factor Orders.  The ADP Employment data will be announced on Wednesday, followed by weekly jobless claims on Thursday.

If the upcoming data reinforces Bernanke’s view that the economy is picking up steam, the gold price could face additional selling pressure.  Alternatively, if the reports indicate a more challenging economic environment, the gold price may rebound as the Fed reconsiders the possibility of QE3.

Rumor has it that some 31 tons of gold were sold

Gold fell some 90 dollars in total, breaking a few one-day records in the process, which the CNBC/ Bloomberg and CNN took pride in reporting. Rumor has it that some 31 tons of gold were sold on the Chicago Mercantile exchange. Shortly thereafter, debates over why gold fell and not stocks or bonds became the topic du jour on most financial talk shows. To that, we would suggest that in the absence of additional money printing AND a rotational benefit from stock/bond markets, a funding deficit was, by default, produced in the metals. That is to say, once again the Bernenk was successful in convincing the markets that the U.S. is recovering nicely without inflation – essentially praising themselves for a job well done. However, taking into account the economic issues at hand, we suspect Bernanke and CNBC will not be bragging for much longer.

We also might add that as Americans continue to find reasons to sell gold, others continue to accumulate it at their expense. ETF holdings (globally) increased by 32 tonnes (or 70.6 million ounces) in February, while on Thursday (following the 90 point drop), India saw physical gold inflows three times the normal average (and the strongest volume since September) – according to UBS sources. That said, a psychological beating has been taken in the metals which can take some time to repair.