After last week's spike low in Gold (GLD) -- down to $1550 per ounce -- the very real possibility of a continued wash out looked very high. From a quantitative perspective, gold was due for a rebound and we've gotten it. Coming into FOMC Chairman Ben Bernanke's semi-annual Humphrey-Hawkins testimony, gold moved back up above $1590 per ounce and once his prepared remarks were complete, the price shot past $1600 to touch $1620.
The pressure gold was under was disproportionate to the quality of the information supporting the bearish case. From the moment that QE IV was announced back in early December the Fed and its proxies have been banging away that they will take the QE punch bowl away before they'd even served the first drink. The yen (FXY) debasement only added to the pressure creating artificial short-term dollar (UUP) strength as I discussed in my previous article on the situation.
It's not like the equity markets believed this story. They have rallied relentlessly up until last week. If the equity markets didn't believe it then why did the gold market believe it? It must just be that catch-all condition of "sentiment" right? Nonsense. Sentiment is another non-analytic way of saying animal spirits or the gods must be angry. It's silly and it's anti-intellectual, though a lot of modern economic theory rests on this. No one could actually be driving these markets in particular ways could they?
Like everything else, traders saw the opportunity to piggy back on the Fed's intention to hold the price of gold down regardless of the cost. And the epic battle at $1696 during the week of January 22nd was a pretty strong signal to those willing to listen that the gold price was going to be held down so joining the party could be pretty profitable for you.
That game can only last for so long and as Dave Kranzler rightly points out in his look at the structure of the COT report from last week, it is obvious that the real joke has been played on those who went along for the ride down. The hedge funds' short position on the COMEX is at biblical levels while the bullion banks covered a tremendous number of shorts leaving much weaker hands holding all of those shorts. And Bernanke was going to go up on to Capitol Hill and ask for a mea culpa from the Senate for his policy decisions? At this point anyone dumb enough to pile onto such a crowded trade now that the bullion banks have covered into this mess is either suicidal or just plain stupid.
With options expiration behind us and the end of the month looming large for the silver (SLV) market - open interest for March delivery is a stunning 23,819 contracts as of this morning with two days to go before delivery notices can be filed - the only thing left was the question of whether Bernanke was going to get up in front of the Senate and tell the world, for real, that the Fed had a definitive time table to end the asset purchasing programs known collectively as QE.
Not only did Bernanke not have that timetable, he went even further by stating clearly that QE was the solution and the cure to the situation and defended its use as the means by which to pursue growth.
Cue the short covering in the precious metals.
The idea that the Fed would cut short QE and allow rates to rise without a fight - a losing fight I might add - the equity markets to fall and the banks to implode before the end of the year was laughable. But the market traded like it was real. Since Lehman Bros. fell in 2008, the Fed has done nothing except meet all instances of debt deflation with more money printing.
Its reasons for this are clear. First, to a banker the banking system is the most important part of an economy, therefore the banks must be saved at all cost. Which banks? Those that have close ties to the Fed. Secondly, it has preferentially pushed people into equities to preserve as much nominal value as possible because a depressed equity market will create serious political unrest.
Last week Alan Greenspan made the remark that the stock market doesn't reflect the economy but rather is the driver of an expanding or contracting economy. And now we are right back to animal spirits again, because by saying that, Greenspan negates all cause and effect and elevates central planning to something just this side of godhood. Create a great stock market and you can create a great economy. This man ran the Fed for more than 20 years and his nickname was "The Maestro."
So, Bernanke went up to The Hill on Tuesday morning and told everyone what they knew in their hearts to be true - that the economy would collapse without continued QE - and the gold market was finally set free of the lie that monetary policy means nothing to the metal's price.
With that lie out of the way and the renewed worry over the eurozone coming back into the market, the threat of monetary instability is returning and that is bullish for gold. Last year, the massive instability over the euro because of Greece was happening against the backdrop of the Fed actively tightening, so bringing down gold to these price levels was easy given the extreme short-term demand for dollars.
This year the situation is different, the supply of dollars is increasing, the petrodollar system is farther along its path to destruction and gold has survived a Herculean effort to keep the price bottled up.
I'm looking for a close this week above $1620 per ounce. That would negate the spike low on the weekly chart and create a powerful one-bar reversal pattern. That gold has already broken last week's high creates a low probability of last week's low being tested. Closing the month near there on Thursday would set the market up in a neutral posture for March. Silver is in more difficult straits as it needs to close above $30.15 to create a similar signal.