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Fade the Gold Short Squeeze Ahead of the FOMC

The over-hyped Swiss gold referendum led to volatile trading for the yellow metal last week. That continued into this week with safe haven buying after the announcement of an early election in Greece and the resultant short covering continued that volatility. However, it’s very plausible that the coming week will show gold with even greater swings.

In less than two weeks the FOMC will meet to discuss the future of monetary policy and are likely to announce that the timing of the first rate hike will be data dependent, rather than based on a pre-determined schedule. The most recent employment print of 326,000 and the improving trend in economic data mean that if the Fed does announce that the first hike will be data dependent, then the markets will begin to price in the rate increase for much sooner, given the strength of recent data. Gold’s response to tapering and its conclusion have shown that hawkish monetary policy is bearish for the metal. This means that gold is in for a severe hit if markets begin to price in an earlier hike.

The effects of the FOMC meeting will dominate trading. Those confident that the Fed will announce data dependence will be looking to jump in early by shorting the metal before the meeting. On the other hand, the bulls will clinging to the hope of some kind of dovish sentiment, however unlikely that is. We can expect to see the impacts of this carry on through this week and continue until Yellen’s press conference.

Moving beyond the very short time period that precedes the FOMC meeting, what is the long term direction of gold? Our view is that gold will fall. The effect of the continual improvement in the US economy means that the Fed has been able to take hawkish action by tapering, concluding QE, and moving towards rate hikes that will drive gold below $1000. The latest employment figures have not changed this, if anything, they have made it more likely. Friday’s print builds on nine consecutive months of gains of more than 200,000 in nonfarm payrolls and it has raised the average gain to 228,000 for each month over the last twelve.

The one of the key risks to this view is a shock event that causes massive safe haven buying of gold. 2014 has so far included many periods of panic and risk off situations that have triggered such safe haven buying. Most recently, the fears around the situation in Greece, the Ebola outbreak, fears around emerging markets early in the year, the situation in the Ukraine that has been an ongoing concern for investors, and the list of events causing safe haven buying in gold continues. Each of these, as well as many other, similar events, have rocked the market throughout the year and caused safe haven buying in gold. In the face of this, gold is still more than 35% down from its 2011 highs.

Even quantitative easing from the European Central Bank failed initiate a major rally in gold, despite being touted by the precious metal perma-bulls as the catalyst for the next rally higher. The reason that none of these factors were able to push gold significantly and sustainably higher is the course of the Fed’s monetary policy. The juggernaut that is the Federal Reserve has been moving towards tightening ever since the prospect of tapering was first announced on 19th June 2013. The building of this momentum, and the improving trend in the US economy that has allowed it, has outweighed all other factors where gold is concerned. The most recent short squeeze has not changed this fundamental situation.

Our views on exactly how far gold will fall are based on technical and chart based elements. From these we believe that gold will reach at least the level of $1030, which is major support for the metal. Beyond this we believe that the movement will be less severe, which this presents less in the way of both trading opportunities and potential profits. As a trading operation this is less appealing so our focus after gold bottoms will be elsewhere, all we will say is that those hoping for gold to reach new highs are likely to be waiting a long, long time.

The latest employment numbers are bearish for gold and are likely to add to the downwards pressure that the metal already faces. This will see the metal trade down to new lows of at least the $1030 level and potentially lower. In terms of risks to this, the key ones are shock events that cause safe haven buying and accommodative monetary policy from the ECB. As 2014 has shown these factors are not capable of changing the tide for gold, at most they can slow its decline. This makes being short gold look very attractive in terms of risk versus reward and it is these dynamics that have led us to increasing our short exposure and fading this rally.

By Sam Kirtley



Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.
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