Gold's Near-Term Future: A Game Of Roulette

Includes: GLD
by: Rohit Savant

Gold prices are vulnerable to sharp moves in either direction over the next few days. The primary driver of prices is expected to be the conclusion of the Federal Open Market Committee (FOMC) meeting on 18 September. The Fed will announce at the end of the meeting, among other things, its plans with regards to its $85 billion monthly bond purchases.

It is now being widely expected in the market that the Fed will announce a reduction in the size of its monthly bond purchases by anywhere between $5 billion to $15 billion.

Based on the popular belief that the Fed will reduce its monthly bond purchases, gold prices already have declined 4.9% from a settlement price of $1,386.40 on 9 September to $1,317.80 on 16 September. Reduced concerns about a U.S. military attack on Syria additionally weighed on gold prices over the past week. Prices could slip lower before the Fed's 18 September announcement, possibly toward $1,280. A decline in prices below this level should not be ruled out, however, with the next support for prices positioned at $1,260.

While many observers assume any announcement by the Fed that it is reducing its bond purchasing program would be negative for gold, this may not be the case. To some extent the idea of the Fed reducing the rate of its bond purchases already is reflected in the sharply lower prices over the past week. If a reduction in bond purchases is announced that matches market expectations, gold prices actually could rise, as the market's expectations would be met but not exceeded. The stock market, which has been going from strength to strength in recent weeks, is much more vulnerable to a major decline on such a Fed announcement; a weaker stock market in turn could benefit gold, as some of the money that exits the stock market could at least temporarily enter the gold market.

If the Fed announces a larger than expected reduction in bond purchases, gold prices would be likely to decline sharply, possibly toward their lows around $1,180 reached in late June. A larger than expected decline in bond purchases is highly unlikely at this time, however.

If the Fed chooses to hold off on reducing its bond purchases until it feels more confident regarding the strength of the U.S. economy it could result in a gold price rally, with prices rising back toward $1,480 or even $1,500.

The most likely course for gold prices over the next few days is a decline prior to the Fed announcement on 18 September and a increase in prices following the meeting. The likely decline in prices over the next couple of days could be a good period to take a long position in gold (NYSEARCA:GLD).

The U.S. economy has been showing signs of strength over the past several months. The economy is not on a sturdy footing, however. Slowing in bond purchases could result in economic growth being derailed. The unemployment rate declined in August to 7.3%, the lowest level since December 2008, but this decline was driven primarily by a reduction in the labor participation rate. The quality of jobs being created remains sub-standard. Inflation in the U.S. is still below the Fed's target rate of 2%. Other economic indicators have been vacillating from strength to weakness, providing little confidence in the overall strength of the economy.

Even in the housing market, the fact that much of the recent strength in housing sales and sales prices has been based on speculators paying cash for the houses undermines the argument that the basic U.S. economy is structurally stronger. Based on the lack of clarity regarding the sustainability of the recent strength of the U.S. economy the Fed seems unlikely to announce a major reduction in its bond purchases this month, if any at all. If it does announce a reduction, it is likely to be at the lower end of the expected $5 billion to $15 billion range.

In both of these scenarios, gold prices should be expected to rise. The rise in prices is expected to be capped by the ongoing price sensitivity among gold market participants.

In the rare event that the Fed exceeds market expectations with regard to a reduction in bond purchases, gold prices will drop sharply. A decline in prices to June 2013 lows is most likely, but if market participants hold off on making fresh purchases on these price declines, to see if prices decline below their June lows it could result in prices slipping as low as $1,100. Declines below these levels are unlikely at this point because of the upcoming festival and marriage seasons in India and China, which could garner demand from these regions on weaker prices.

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.