How do you know when a central banker is lying? "His lips are moving." Ok, so it's an old joke but an accurate one. FOMC Chairman Bernanke gave the first part of his semi-annual report on monetary policy to the U.S. Senate banking committee - and for the first time in months he said what he is actually doing. The asset purchase programs known as QE III and QEIV have been in full flight now for the past three months, but from the moment they began the talk has been about how quickly the Fed would reverse policy and withdraw the money. Bernanke has been threatening us with taking the punch bowl away for five years now but he never has. And, after Tuesday's testimony it should be clear that he never will.
The response in the Gold - and the SPDR Gold Trust (NYSEARCA:GLD) -- market was as swift to the upside as the liquidation the week prior was to the downside. Gold has been in a brutal consolidation, which has been trading against its fundamentals now for the past three months, since the QE IV announcement.
For the past three months we have been hearing an endless litany about how the gold bull market is over. But the conditions that created the bull market have not been fixed. Bernanke continues to berate Congress to get spending in line but also feels the upcoming sequester will be damaging to the recovery that is supposedly taking place.
He tells the truth that high gasoline prices and high unemployment are hitting the average family hard which, he attributes to high oil prices. But oil prices are high not because of aggregate demand outstripping supply, but because the U.S. dollar is weakening with respect to marginal oil demand. It is simply taking more dollars to buy a barrel of Brent Crude (NYSEARCA:BNO) because those dollars are no longer needed as much to settle oil trades.
What Bernanke won't tell you is that he likes it this way. To keep the U.S. dollar relatively strong in the face of weakening petrodollar demand higher prices are needed to flow the same number of dollars through the foreign exchange markets as more oil is traded directly for gold or other currencies.
In 2012 China signed more than 30 bilateral trade agreements in which trade could be settled with each other's currency bypassing the U.S. dollar completely. Across Southeast Asia the yuan (NYSEARCA:CYB) is becoming increasingly important with important major currencies like the Malaysian Ringgit and Singapore dollar (NYSEARCA:FXSG) tracking for most of 2012 closer to the yuan than the dollar. China just nominated ICBC as the official yuan clearing bank for Singapore last week, which will further increase flow around the region, taking some of the burden off of Hong Kong. This should increase the correlation between the Singapore dollar and the yuan. Add in the open trading of oil contracts on the Shanghai exchange with physical delivery backed by Russia and we can see where this is headed.
Lastly, since gold has been steadily flowing from West to East - Asian central banks are buying gold at historic rates now - these structural changes to the international oil and trade markets will have a large impact on how gold is valued.
Bernanke and the Fed will not and, for all practical purposes, cannot stop the bond buying programs. He fundamentally believes that deflation is to be avoided at all costs and debt deflation will be met with continued money printing and balance sheet expansion. This is fundamentally bullish for gold in dollar terms and his testimony before the Senate today will likely be looked back as the beginning of the next up leg in the gold bull market. I recommend the physical gold ETFs and closed-end funds over GLD, such as the ETFS Physical Swiss Gold Shares ETF (NYSEARCA:SGOL) because there is far less risk associated with its assets due to its low exposure to paper gold contracts, unlike GLD.