Though still early, the immediate reaction sent the front-month contract for gold futures under the psychologically important $1,600/ounce level.
Last week, I warned that Jon Hilsenrath's endless pumping was pushing another QE premium into values within the gold complex, and recommended a short trade to take advantage of the initial blow following the lack of QE.
In the beginning of this week, market participants began to realize that the Fed was probably not going to ease, given the circumstances. However, let price action be your guide; the last several FOMC meetings have had similar sentiments prior to the announcements, yet the gold market has just not been able to get it right. I first figured out this dynamic back in June, though my recommendation to buy it back afterwards was clearly misguided, and I soon went back on that.
Though gold may rebound a bit by market close, I'm still bearish on the intermediate term outlook for both GLD and GDX. Here's why:
- Lack of a catalyst: This is quite simple. Though the market keeps falling for Hilsenrath's unsourced rumors, the reality is that until equities sell-off on the order of at least 10-15%, oil drops below $90, and the grains commodity complex sees less speculative activity, QE is off the table. Equities haven't quite figured that out yet, but the gold market is starting to. I'm also quite skeptical regarding the chances for a third round of long-term refinancing operations (LTRO) courtesy of the ECB; a shortage of adequate collateral and the ability to calm markets (for now) with "believe me" speeches makes LTRO unlikely. Furthermore, Germany has made it quite clear they are against any bond-buying or large-scale asset purchase (LSAP). Finally, the ECB wants to keep as much pressure on governments to address structural deficits (i.e, cause deflationary pain). When this actually happens, then the ECB will add incremental liquidity to the marketplace.
- U.S. Elections also make QE unlikely: Though some members may worry about action looking like it came from the White House, the real worry here would be a spike in gas prices right as Obama is seeking reelection. If the Fed were to ease in September, oil prices would likely run-up significantly as the risk-on trade took hold. With Fed easing likely pushed to late 2012 at the earliest, gold has no legitimate catalyst.
- Most of the miners are still trading at rich valuations: When we look at the top holdings in GDX: Goldcorp (GG), Newmont Mining (NEM), and Barrick Gold (ABX), the only reasonable valuation is ABX, trading at 8 times earnings. I recently made the argument that a lot of the forward estimates from major brokerages are predicated on $2,000 gold, which I simply don't see as being realistic for 2013, all else being equal. The big banks all have calls for $2,000 gold, and you can be sure the analysts at the banks are not publicly diverging from their employers' opinions.
- Strong USD trend: Gold's main weakness has been a result of a strengthening U.S. dollar. I know the gold-bull argument against the dollar: constant debasement and loss of its reserve currency status will lead to a worthless USD. Long-term, perhaps this argument holds a bit of water -- for now however, prices move first, fundamentals come second.
(click image to enlarge)
The incredibly strong USD upward trend that began in May has slowed recently on the back of undeliverable promises from the ECB. As economic reality reasserts itself and the next leg of the euro crisis heats up, expect the USD to resume its upward march, further pushing down on gold prices and the miners.
As has been the case in post-FOMC announcements with similar sentiment, the initial reaction has been strong selling pressure in the gold complex, followed by a moderate rebound as the market closes. The next day has often brought more sustained selling pressure. I expect that the mere "Fed-speak" that has placed a put under both equities and gold will have to be backed by legitimate action soon.
My intermediate term outlook is for the gold complex to drift lower before the next major EU event, at which point both the ECB and Fed are likely to inject hundreds of billions, if not a few trillion, in incremental liquidity in the form of QE and LTRO 3.
I sold my puts on GLD in the first few minutes post-FOMC, but am looking for another attractive area to reinitiate -- perhaps by market close.