Obama's Re-Election: Expectations Say The Fed Will Print

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Includes: FXE, GLD, UUP
by: Peter Pham

Gold is a funny commodity. It is more than the most political of commodities; it is the only commodity that can credibly substitute as money created by central banks, though to hear them tell the tale that is a delusional fantasy. Watching the U.S. Presidential election unfold was illuminating as the action in the gold pits mirrored the stream of vote totals that came across the news wires. Romney is up in Florida? Gold goes down $1. Obama won Pennsylvania in a laugher? Gold goes up $3. The marriage of gold to the political system is so complete that anyone attempting to trade its swings without the deepest of pockets will get burned to a crisp and the ashes ground into the finest of powders.

While there are a myriad of factors that go into the minute-to-minute price swings in Gold it is my experience that all trading has to revolve around filtering out as much noise as is practical and focusing on the probability of the next bar going higher or lower. This is especially true of Gold trading, which, because its price is fraught with so many political implications, I prefer to trade based on simple yet powerful signals.

Ultimately, Gold flows are based on the market's expectations of how much monetary inflation there will be in the near future. Because monetary injections take time to show up price signals like CPI and PPI are lagging indicators and worthless to traders. On the other hand day to day inflation expectations can be assessed by looking at the short-term vs. long term bond spreads for inflation indexed assets, in this case TIPS. If expectation of inflation are rising then real yields are dropping and with it the yield on TIPS. Money will flow into short-term, more liquid assets like overnight bank paper.

So, to construct a good inflation expectations indicator what I have found works best is the spread between the OIS 3-month swap rate and the 10-year TIPS yield. If the spread is rising bond traders are expecting inflation in the future and therefore are hedging it with longer dated, higher-yield assets and when it's falling they are expecting monetary contraction as money flows preferentially into the interbank system to shore up liquidity.

Pretty simple right?

Well, not so fast, unfortunately because since Lehman Bros. the OIS swap rate has been manipulated down and kept below 0.2% while 10-year TIPS yields have been steadily ground down to negative real yields. Because of this the TIPS yield exerts a tremendous influence on the indicator. And while this hard manipulation of rates and some obvious price-capping in Gold at times has lessened the strong correlation of this indicator in terms of the U.S. Dollar (NYSEARCA:UUP) price of Gold it still serves as a strong indicator of when the price-capping in Gold has reached its limit.

Here's my chart of the past 16 months in Gold to serve as an example. All charts in this article have been updated through the close on November 7, 2012.

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Note the two periods of extreme disconnect between the indicator and the price of gold, first in December of 2011 and then this past summer. Both times the indicator kept looking for higher gold prices but the market did not cooperate. Then notice what happened after the suppression of the price ended the price of gold shot up both times from $1525 to near $1800 per ounce. Since the September peak, the sell-off in gold properly mirrors the expectations of bond traders and the indicator since Obama's re-election on November 6th turned higher along with the price of gold.

Markets can always be manipulated in the short-term and there were strong political reasons for gold to have been suppressed all summer. For anyone who has watched gold's action regularly for years knows that the violence of some of the attacks on the price this summer were some of the most intense in the past few years. Given that ferocity of selling pressure that bulls were able to hold the $1525 area through May and June is a testament to how strong the buying pressure is out there. Now that the election is past and Bernanke's job is safe from the whims of Mitt Romney, inflation expectations and gold's price should continue to re-align.

For further proof of this thesis look no further than the same chart - minus the 19 and 34 DMA's - with the price of gold translated into the euro, which you can trade with the CurrencyShares Euro ETF (AMEX:FXE).

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Again, note the current strong disconnect between the size of the down leg since the mid-September peak and the indicator. This is saying quite clearly that the move down was way over done in reaction to the euro/gold price reaching a new all-time high post QEIII announcement by the Federal Reserve.

The monthly price of the SPDR Gold Trust ETF (NYSEARCA:GLD) and some statistics on potential price moves for the month: The average range (high to low) for GLD per month is $10.45, based on the past 44 months of data. The range so far this month is $4.87. The range last month was $9.47. The average move below the current month's opening price is $4.79 and the difference between the open and the low this month has been $4.87. So far, GLD has acted normally.

What this tells me is that for the rest of the month any week where the closing price is higher than the previous week's high will create a high probability setup for a short-term bottom in the price of gold and potentially sets up a resumption of uptrend if the October high of 1798.05 on the December contract is breached - which coincides with $174.07 per share for GLD.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.