Black Wednesday for Gold

While the other precious metals ended the month of February with a gain, gold suffered a huge one day loss, which wiped out the gains made during the month. Gold even fell below the close of January and thus, ended February with a loss. The trigger for this sell-off was disappointed irrational expectations.

Last Wednesday, Fed chairman Bernanke had one of the semi-annual testimonies at the Congress. And the sell-off set in with the release of the written text of his testimony. Normally, it is the case that words said move the markets. Just remember all the reports citing official sources from the German government, which moved markets during the last two years of the eurozone debt crisis. However, in the case of the Bernanke testimony, it was words not said which sent gold sharply lower. While the markets awaited an announcement that another round of quantitative easing would be implemented, the Fed chairman provided no hint about QE3.

Expecting that Fed chairman Bernanke would announce further measures of quantitative easing at a Congress testimony was rather irrational for several reasons. Central banks are eager to defend their independence. Thus, announcing policy measures at a Congress hearing could easily create the impression that the policy instruments were only applied due to political pressure or to please the Congress. Furthermore, it is not just the Fed chairman deciding about monetary policy measures, but all voting members of the Federal Open Market Committee. Decisions of the FOMC are released after the meeting in the official statement. In addition, the minutes of the recent FOMC meeting should include hints that the majority of the FOMC voting members would be ready to embark on QE3 at the next FOMC meeting. All one could find is the standard phrase that the Fed would be ready to act when needed. However, it is rather irrational to interpret this as a hint for announcing QE3 at the semi-annual testimony at the Congress.

When the Fed speaks, markets normally listen. However, this has not been the case recently. Only a couple of days before the Bernanke testimony, the governor of the Federal Reserve Bank of New York warned that Wall Street would have too high expectations for QE3. That still many hedge funds and traders expected an announcement of QE3 could only be interpreted as an irrational case of selective perception. This is another example for falsifying academic theory that financial markets follow rational expectations and are always information efficient.

The US labor market is improving, but the pace of job creation is too slow from the Fed’s point of view. However, this is not automatically leading to further monetary stimulus measures. The growth of US GDP also plays a role for the FOMC members in the process of decision making. The GDP growth in the final quarter of 2011 had been revised up to 3.0%. The capacity utilization is also pointing upwards and is not far below the levels prevailing before the financial crisis of 2008. Thus, the Fed could maintain the speed of monetary expansion but it is unlikely to accelerate further.

The US dollar strengthened after the Bernanke testimony disappointed traders hoping for another round of quantitative easing. However, QE3 is not a necessary precondition for a weaker US dollar. The Fed projected that exceptionally low interest rates will prevail until late 2014. The ECB is currently now showing any willingness to cut the refinancing rate below 1%. Thus, it is still attractive to borrow in US dollars and to invest in other currencies. Therefore, the US dollar is probably to remain a supportive factor for gold in the medium-term. However, it could not be ruled out that the US dollar would be regarded as a safe haven in a geo-political crisis, especially in the Middle East. But in such a crisis, gold would probably also be sought as a safe haven.

The technical picture for gold has worsened considerably due to the plunge on Wednesday. It could not be ruled out that the rise on Thursday is just a typical “dead cat bounce”. However, there should be some solid support in the range between 1640 – 1650$/oz. Currently, we would regard a test of this level as a good buying opportunity.