FOMC Meeting: Is Gold Entering Into A Prolonged Bear Market?

by: Boris Mikanikrezai

Following the Federal Open Market Committee (FOMC) Meeting, the precious metals complex has been under hard pressure with gold losing more than 2.50% on November 20.

The Fed's stance has been more hawkish than expected by the market. FOMC participants expect improvement in labor market conditions (consistent with the Committee's outlook), which could justify a slower pace of purchases in coming months (See the FOMC minutes).

If we have a look at price actions across financial markets, it seems that market participants interpreted the conclusion of the FOMC Meeting quite differently. Indeed, gold (NYSEARCA:GLD) dropped by roughly 2.5% on November 20 and is still down on November 21 while US stocks (NYSEARCA:DIA) fell by only just 0.41% on November 20 and rose by 0.70% on November 21 .

This is attributable to the fact that the trend in the gold market is different than the trend in the US stock market. Since the beginning of 2013, the US stock market has been in positive territory while the precious metals complex has been in negative territory. It seems clear that the precious metals complex is much more affected negatively by bearish news than positively by bullish news.

The sudden drop in gold on November 20 by $10 within 10 seconds illustrated gold traders' fears and a lack of liquidity in the market. What would happen if the FOMC decision would have been more dovish than expected? It is likely that the precious metals complex would have experienced a mini-rally for a few days before being sold amid fears and bearish momentum.

If I am correct and the trend is bearish, the question now becomes when will the yellow metal hit a bottom?

I believe that the sentiment in the precious metals complex needs to be over-bearish in order for gold and silver to hit a bottom. From an historical perspective, it is clear that the bottom in gold in 2001 was reached with major bearish sentiment and the peak in gold in 2011 was reached with major bullish sentiment.

Now the question becomes is the current sentiment bearish or bullish?

It is relatively hard to gauge the sentiment in the market as it is purely subjective. Some analysts rely on CFTC data or use a sentiment index to measure it. These methods can lead to misleading conclusions.

I argue that the sentiment in the precious metals in still bullish today due to my observation in the Silver ETFs.

Exhibit 1: Silver ETFs

Source: Bloomberg

Since the beginning of the year, gold and silver have dropped sharply but the developments in ETFs have been different. As shown in Exhibit 1 and Exhibit 2, Gold ETFs have plunged in 2013 while Silver ETFs haven been stable.

Exhibit 2: Gold ETFs

Source: Bloomberg

Investors need to know that Gold ETFs are mainly held by institutional investors whereas Silver ETFs are mainly held by private investors. Consequently, it is fair to say that because institutional investors are risk averse, the sharp decline in gold forced them to reduce their exposure in gold. However, it is clear that private investors with an exposure to silver via ETFs did not reduce their exposure as they still believe in the bullish case for silver and the precious metals complex in general.

The developments in the Gold versus Silver ETFs clearly show that the sentiment is still bullish.

In sum, even though gold and silver declined sharply this year, the current sentiment is still bullish. Gold and silver will eventually hit a bottom when the sentiment becomes very bearish. The sentiment can become bearish if redemptions in Silver ETFs are witnessing because private investors will signal to the market that they are now pessimistic about the precious metals market outlook. Therefore, it will indicate that we are close to a major bottom and the trend will soon become bullish.

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.