Is Ben no longer the gold bull’s man?

The most surprising move in the gold market took place last Friday. Not only the gold market, but also the stock, bond and foreign exchange market awaited the speech of Fed chairman Ben Bernanke at the Boston Fed conference last Friday. While he said that nonconventional policy would have costs and limitations, the also made it clear that everything else equal, there would be a case for further action. This is another indication that the Fed is ready to implement a new round of quantitative easing. However, gold did not rally to a new high as it did the days before. Gold was dragged down by a rebound of the US dollar and rising US Treasury yields.

The core inflation data released earlier last week in the US support the point made by Fed chairman Bernanke and other FOMC members. Prices at the factory gates as well as for consumers rose by a mere 0.1% on the month. This indicates that the core PCE, the favorite inflation indicator of the Fed, is likely to edge down further. While the Fed has not an explicit inflation target, it appears that the FOMC would be comfortable with a rise of the core PCE by 2% yoy. Some gold bulls argued that quantitative easing would eventually lead to hyperinflation and the only protection would be gold. Therefore, it appears surprising that gold declined after the speech of Ben Bernanke.

Many traders act according to the old market rule of buying the rumor and selling the fact. However, the speech of Bernanke was at best a hint that quantitative easing is high on the agenda, but it was not yet the fact, which should trigger profit taking. However, there might have been some awakening among the bond bulls. In the case the Fed would succeed with quantitative easing to push the yoy-change of the core PCE back to around 2%, and then the real yield on 10year US Treasury notes would be just too low with nominal yields at 2.5%. This appears to be a major risk of quantitative easing. Yields have already fallen strongly this year and purchases by the Fed might drive them even lower. Then nominal yields would be too low compared with the implicit Fed inflation target. Bond investors could take profits and send yields higher again to maintain a sufficient real yield and risk premium. This would also have an impact on the US dollar and therefore, also on gold.

Another surprise came last Friday with the release of the weekly CFTC report on the “commitment of traders”. Large speculators have still added to long positions, which reached a new record high at 304,564 contracts. However, they opened far more new short positions, thus, the net long position declined by 3,746 to 255,874 contracts. Since gold started its rise of around $210 at the end of July, there were also some weeks with a decline of the net long position of the non-commercials. But these declines were smaller, which sends a warning signal that hedge funds might get less bullish on gold.

The gold holdings of the SPDR Gold Trust ETF, showed a similar pattern. After reaching a high at 1,305.7 tons on September 29, inventories declined to 1,285.2 tons on October 13. However, last Thursday, the gold holdings jumped again to 1,304.3 tons. Thus, it might be premature to conclude that large speculators abandon ship. Nevertheless, gold bulls should have an eye on the holdings at the ETFs and the non-commercial net long position.

The decline of gold despite bullish news is a warning signal that gold bulls might have to take a breather. As gold did not reach the high of the preceding day, Thursday’s high marks a pivot high at 1,387$/oz. This alone is not worrisome as long as gold holds above the recent pivot low at 1,325$/oz. While technical indicators are bullish, the ADX, which measures the strength of a trend, sends a warning signal. This indicator is at 67, which signals that the rise might have gone too far. The last time, this indicator showed a higher reading was in November last year. It was followed by a 12.4% decline. But as long as other indicators don’t point to a reversal, we would follow the old market adage that the trend is your friend.