Recent Gold Price Action Misunderstood

Includes: GLD, PHYS, SLV
by: Boris Mikanikrezai

Gold (NYSEARCA:GLD) rose sharply by 3% from $1,282.70 an ounce to $1,320.10 an ounce on October 17, 2013, as an agreement to raise the U.S. debt was reached at the last minute. Have gold prices really been driven by the U.S. debt deal?

Let's have a look at gold prices from an intraday perspective. On Thursday, October 17, just after 4:00 am. EDT, gold surged by 3% in only 10 minutes when 18,000 lots (1.782 million ounces of gold) changed hands. This extreme move is likely to be attributable to unusually low liquidity. As a result, investors should not be over optimistic about this extreme move. We need to see increased ETF inflows and sustainable gains in gold price to confirm a bullish trend.

For the past few weeks, gold has not reacted so much to fiscal problems in the U.S. as investors expected a deal over the debt ceiling to be reached at the last minute as it happened in 2011. Moreover, from a fundamental perspective, a debt ceiling agreement is negative for gold as it reduces safe-haven demand. As I wrote here in a previous article, if the U.S. government temporarily had missed a coupon payment, Treasury rates would have increased significantly due to a "flight" to liquidity and gold would have surged sharply while the dollar would have declined in the very short term due to uncertainty and fears similar to what happened following the Lehman Brothers collapse in 2008.

As the agreement between Democrats and Republicans cannot explain the recent move in gold price, let's explore the factors that could be attributable to the upside in the yellow metal?

1)The recent comments of Chicago Fed President Charles Evans

The relationship between gold prices and FED Quantitative Easing (QE) expectations is very strong. As a matter of fact, a spike in gold price was seen on September 18, 2013, just after the FED announced that it would continue its monthly $85 billion bond purchase program at the conclusion of the FOMC Meeting. On September 20, 2013, St. Louis FED President James Bullard said that a small taper was "possible" in October and the gold market gave up all the gains it had made.

Similarly, on September 17, 2013, gold had been heavily impacted by Chicago FED president Charles Evans comments about QE. In a speech to be delivered in Madison, he said: "I expect our overall stance of monetary policy to remain highly accommodative for some time to come. It is not yet time to remove accommodation. The data are still not definitive enough to say that now is time to adjust". Consequently, the market re-repricing FED QE expectations caused a strong decline in the dollar and a sudden spike in gold.

2)The U.S. credit downgrade by China's leading credit rating agency

Dagon downgraded the US Sovereign Credit Ratings to A- from A as "the fundamental situation that the debt growth rate significantly outpaces that of fiscal income and GDP remains unchanged." Dagon added that "the government is still approaching the verge of default crisis, a situation that cannot be substantially alleviated in the foreseeable future."

As it was the case in the summer of 2011, even though an agreement to raise the U.S. debt ceiling was reached at the last minute on August 2, 2011, Standard & Poor's decided to downgrade the U.S.' AAA credit rating on August 6, 2011. It was a big catalyst for gold. As a reminder, gold rose by roughly 15% from $1,665.60 on August 3, 2011, to $1,920.00 on September 6, 2011, as demand for gold ETFs (NYSEARCA:PHYS) surged significantly. Meanwhile, silver (NYSEARCA:SLV) rose slightly by 2.50% during the same period.

In sum, gold did not soar due to an agreement over the debt ceiling between Democrats and Republicans. It rose due to the U.S. Sovereign Credit Ratings downgrade by China's leading credit rating agency and a sudden change in QE market expectations.

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.