Gold Needs A New Catalyst

Includes: GLD
by: Tim Iacono

Just in case it wasn't already clear, this week's Federal Reserve policy meeting drove home the point that actions by the central bank are no longer a positive catalyst for gold (NYSEARCA:GLD). Whatever the Fed said or did was going to be negative for precious metals.

If the committee began to "taper" their money printing effort or signal that such a move was coming, the gold price was likely to fall and it did. In the press conference following Wednesday's policy meeting, Fed Chief Ben Bernanke said, "The committee currently anticipates that it will be appropriate to moderate the monthly pace of purchases later this year..." and the gold price fell along with just about every other asset.

If, on the other hand, the Fed announced no change in policy and a continuation of their $85 billion bond buying program, the gold price was also likely to fall since more traders would shift more money out of precious metals and into stocks, a trade that has worked very well since the Fed's QE3 program got underway late last year.

Fear of inflation due to ongoing Fed money printing - what has been one of the key drivers of the gold price in recent years - has nearly vanished and the gold price has suffered.

Now, that's not to say that higher inflation won't someday arrive. U.S. banks hold nearly $2 trillion in excess reserves as a result of the Fed's stimulus in recent years. This is up from zero in 2009 and, should banks decide to lend this money out, then conditions could change very quickly.

But, that hasn't happened and, at this point, virtually no one thinks it will.

The proverbial "boy who cried wolf" is no longer getting anyone's attention, but that doesn't mean there isn't a real wolf out there.

Financial crises have been another key driver behind the rising gold price in recent years. Though today's global economy and financial markets are clearly not a picture of health, they are far better than in years past when banks were collapsing around the world and then a seemingly endless credit crisis developed in Europe and fiscal crises in the U.S. were the norm.

Relative stability has removed another catalyst for higher gold prices. Here too, extrapolating into the future based on recent events may be a mistake since nothing has really been solved in the global financial system. Money printing by central banks and deficit spending by governments have "papered over" some very serious problems, most of which derive from reaching the "end of the road" in a multi-decade credit expansion that went bust about five years ago.

But, stock prices and real estate values are rising again (thanks in large part to central bank money printing) and, when asset values are rising, investors and traders seem to ask fewer questions.

Clearly, gold needs a new catalyst if it is to reverse course before sinking back below $1,000 an ounce this year.

What could that be?

The gold price appears to be headed toward the cost of production which, normally, would indicate the price can't go much lower. With the recent strength in energy markets, those production costs are not going down, however, the bad news here for gold bulls is that it will take some time for shuttered mines and a slowdown in production to impact the supply/demand picture.

Should precious metals prices continue to fall, you might hear a lot about this next year, but not this year.

If some new catalyst does materialize over the near term, it will probably involve Asia and/or the physical market for gold and/or silver.

To be sure, a sharp increase in physical gold demand in Asia that has more than offset ETF selling in the West has been one of the more remarkable subplots in the story of gold's recent slide. Moreover, with the gold price now ready to head even lower, Asian demand for the metal could increase even further.

It's important to remember that most people in India and China don't buy precious metals as a "trade". People in Asia buy gold because it has functioned as a reliable store of wealth through the centuries and little they see in the world today gives them much confidence that paper assets are better.

Gold has been flowing from West to East for some time now, but that move has accelerated sharply in recent months as prices have fallen. Sometime in the month or so ahead, the World Gold Council will report record shattering second quarter gold demand in Asia, but this, by itself, may not move markets.

Futures traders and most money managers could care less about demand in Asia, however, someday it might make a difference. Inventories at the COMEX in New York - the most important exchange for gold futures trading - has fallen sharply in recent months at the same time that buyers are taking delivery of gold at astonishing rates in Asia. India and China appear determined to buy as much gold as they can at lower prices and we'll soon find out if there is enough metal available to satisfy them.

When and how some unexpected event in the physical market develops is impossible to predict and how traders react is also unknowable, but this is probably the best near-term catalyst for a higher gold price.

Disclosure: I am long GLD. 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.

Additional disclosure: I also own gold coins.