When Will Gold Prices Turn?

Includes: GLL
by: Adam Rabie

It's no wonder markets have been confused over Federal Reserve policy, with an unusual amount of vocal dissent from within the Fed hitting the public over the last couple months. Markets are used to a united Federal Reserve, with at most one fringe member voicing complaints. But if you read the latest Fed minutes, you would think a near majority of the Fed was fearful of the Fed's aggressive policy actions, and the pace of stimulus would soon begin to slow.

Bernanke Privately Tells The Real Story

In closed door meetings, the Fed Chairman Ben Bernanke's true intentions are revealed, according to a report out today from Bloomberg. Why private or even government entities are able to hear privileged monetary policy insight is a question in itself, but I'm more concerned with the reality that no one can stop them.

Bernanke has reportedly told unnamed people in a meeting with the Treasury Borrowing Advisory that asset bubbles are not a concern to the Fed, and do not pose worthy risk to the economy. These kind of comments are not that surprising coming from Bernanke. Bernanke's view of the economy at present is that capacity utilization remains low considering the level of the unemployment rate. Moreover, inflation is growing below the Fed's 2.5% target, according to their favored inflation measure, Personal Consumption Expenditures.

I've been arguing recently that the markets should stop focusing on the hawkish messages from non-voting members, or voting members with little influence, and rather pay pure attention to what Bill Gross calls the three musketeers -- Ben Bernanke, Janet Yellen and Bill Dudley. The Fed's three musketeers are "all for one and one for all" in their plan to continue and perhaps increase stimulus levels -- markets should have never doubted this. All market participants had to do was listen carefully to those at the helm of the Fed so they could reach the inevitable conclusions sooner.

Bullard Clarifies Comments: "Fed Policy To Stay Easy For A Long Time"

James Bullard of the St. Louis Fed and an FOMC member went on CNBC saying his main message is to convey to markets that Fed policy will stay easy for a long time. He noted, as many already realize, that markets have not woken up to the Fed's aggressive switch from operation twist to an outright quantitative easing, resulting in tens of billions being printed a week. Even last week, $20 billion in fresh cash was added to the Fed's balance sheet.

This comes after a few weeks of media reports regarding Bullard's apparent hawkish insight into the future of Fed policy, which fueled market fears that the Fed would end quantitative easing purchases as early as midway into the year. The gold price fell after comments from Bullard were initially released, and continued falling on any corroborating news coming out of the Fed in the last while.

How Long Will It Take Gold Markets To Turn Back Up?

What most people forget is that following QE1 and QE2, the price of gold actually fell for the first couple months. Well into QE2, interest rates were also rising, despite massive Fed purchases, only to eventually drift down once the Fed's easing measures got a handle. Why should QE3 be any different?

See gold prices falling three months into QE1 (Gold is in blue, Fed printing in red):

See gold prices falling three months into QE2 (Gold is in blue, Fed printing in red, 10Y Treasury Note in orange):

See gold prices falling three months into QE3 (Gold is in blue, Fed printing in red):

So how long will it take gold to react this time? If the three-month historical cue has any meaning, then the price of gold is already overdue for a rise. QE3, however, is the first QE that is arising in the midst of apparent dissent within the Fed, which the markets are clearly buying into. This could be why gold's decline has extended a bit past its due.

Since Bernanke et al are now out trying to debunk fears of Fed hawkishness, we can now expect prices to turn relatively soon. This Tuesday, Bernanke testifies before Congress, which could serve as a catalyst for prices to turn. The Fed's March 20th meeting may also prove to be the day gold prices turn around. Nonetheless, sooner or later, gold markets will revive and interest rates will fall again, since the Fed is as determined as they were in the past to achieve such ends.

Position Yourself To Gain From Gold

As I've noted before, the low volatility over the last 12 months in both the Fed's balance and the price of gold could have a strong reversal given the Fed's balance sheet growth trajectory. This makes options with a low implied volatility a potentially worthy mechanism for exposing oneself to the seemingly strong possible upside in gold prices.

To position yourself in the options market, consider purchasing puts on ETFs that short gold. This allows you to protect against ETF management and slippage risk while still gaining upside exposure to metals. Put options on funds like the Proshares Ultrashort Gold ETF (NYSEARCA:GLL) or similar short and short leveraged ETFs that are offering grand bargains on the underlying price and volatility if, like me, you expect both to rise in the near future.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in GLL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.