After Gold's No-QE3 Plunge, Market Clear For Another Rally?

Make Money Blog; Gold’s violent plunge on Wednesday sent chills down the spines of investors, who ran for the exits as the yellow metal fell nearly $100 at one point. 
While the consensus suggests the market meltdown was a consequence of Fed Chairman Ben Bernanke’s failure to suggest QE3 is on its way, the speed and magnitude of the decline was completely unexpected.  It’s up to physical buyers now, according to UBS’ Edel Tully, to show if the decade-long gold rally suffered technical damage or if the “leap-year breakdown” was a one-time event.

The yellow metal had been trading around a three month high before plummeting on Wednesday, falling as low as $1,693.20.  By 4:37 PM in New York on Thursday, COMEX gold had rebounded and was trading up 0.3% to $1,717.10 a troy ounce.

Silver completely broke down on Wednesday too, along with major gold miners like Barrick Gold, Newmont, and Goldcorp.  All were trending upwards on Thursday.

What caused such a violent drop?  Evidence points to Fed Chairman Ben Bernanke’s omissions regarding further easing, and QE3 specifically, in Wednesday’s Congressional testimony.  Dennis Gartman and UBS’ Edel Tully agree on that, and so does the price chart.  Gold fell off a cliff around 10 A.M. New York-time Wednesday, as Bernanke was on Capitol Hill.  Market recognition that the ECB’s recent LTRO liquidity injection could be the final intervention by the institution headed by Mario Draghi in the near future was also a factor, Gartman adds.

No matter where one looks at gold’s price action, though, the plunge is larger than warranted.  As Tully explains, Bernanke’s comments “hardly contained any dramatic surprises and his stance was pretty much unchanged from the Jan. 25 post-FOMC press conference.”  Recall that the Fed changed its policy regarding future forecasts in that meeting, announcing it expected rates to remain in the zero-range at least through late 2014.  Tully explains:

So if this is also about a QE response, then we have to look at where gold was trading before the FOMC’s comments in January that inserted the 2014 time-frame on rates. Yesterday’s price action wiped out nearly all of the QE3-premium gold had been enjoying since the FOMC announcement in late January. So based on that alone, further gold liquidation should be limited.

Gold markets are not that simple, though.  Tully goes on to write that gold’s incredible 2012 rally was being held up by the fickle speculator community, known to run for the hills at the first sign of danger. “Our hesitancy right now stems from the fact that the buying on this break has been one-sided so far. And it’s not just the physical market that has been staying out of the action; the same applies for ETFs. So, for now, gold’s short-term destiny is in the hands of the spec community, a group known for its fickleness,” explained Tully.

Since gold zoomed past the $1700 mark, the build-up in positions was at a very fast pace.  As mentioned above, physical-demand, along with ETF demand, was extremely low.  Markets, according to Tully, were beginning to look stale, which raises the question of what happens moving forward.

Both Tully and Gartman agree that gold’s fundamentals remain intact.  Central banks across the “developed” world are still expanding their balance sheets, feeding excess liquidity and debasing their currencies.  Inflation is beginning to pick up, particularly on the back of rising energy prices (as crude oil surges), and supplies are still limited.

The physical community will dictate the pace of the market, helping to set a price floor Tully says.  While gold moved past $1,720 Thursday, order volumes were very high at the Shanghai Gold Exchange around $1,680, suggesting that could be a possible floor.

Downside risks remain, though, particularly regarding Fed policy.  It doesn’t seem like markets have begun to discount higher rates before the 2014 time-frame, but any indications that rate hikes are a possibility would be a weight on gold prices.

source; forbes.com

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Posted in: Ben Bernanke,Gold