Pop Goes The Gold Bubble

| About: SPDR Gold (GLD)
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Summary

Richly valued gold may be doomed either way the Fed goes in July, if it raises interest rates or pauses for another month.

A surprise rate hike in July would cause a significant recalculation of Fed expectations and a severe price adjustment to gold.

But even if the Fed pauses, recently enriched gold could decline as capital migrates to risky assets from safe stores.

It appears to me the gold bubble is due to pop, and a July or near-term rate action should do the trick.

Pop goes the gold bubble if the Fed raises interest rates Wednesday because of the lift it would give to the dollar. It's a prospect the market has priced out, but I believe it is far more likely than most expect. In fact, I'm betting on it because of the market's extreme divergence I see from the Fed's perspective and the gross imbalance of risk to reward. And even if the Fed holds rates steady again in July, I anticipate richly priced gold will give way as fear fades and equities rally some more.

First a Look Back

In my last report on gold which may have been misinterpreted by those who failed to read past the title, I suggested gold should recover its losses incurred intra-week last week on inaction by the European Central Bank (ECB). Gold recovered ground to close the week after the ECB meeting, which included a press conference in which ECB Chair Draghi praised the resilience of the eurozone economy to Brexit thus far. The outcome meant the previously penalized euro could gain back some ground versus the dollar. However, the dollar recovered much of that again on Friday of last week as the event in Munich, Germany unfolded. Gold held against that headwind, though, as investors likely contemplated risk to America given that developed and well-guarded Germany is seen by many as like the U.S. Gold would also be expected to give way as the Democrat Convention comes to pass hopefully without incident. And yet another event threatens to severely impact gold prices this week, though there's little expectation for it in the market.

Today's Catalyst

The Federal Open Market Committee (FOMC) is intimately engaged now in its July monetary policy meeting, with its decision due Wednesday afternoon. When last it met, concerns about a weak May jobs report and trepidation ahead of the U.K. referendum kept the Fed from acting. Because of the realization of Brexit, most market participants now believe the Fed will not act again this month, and many believe the Fed is sidelined for the year. I think they are grossly mistaken.

The economic impact of Brexit is far from being realized and is still unclear. But while many economists see economic issue for the U.K., few see it rubbing off on America. I believe the Fed was mostly concerned about the financial market volatility it might have caused last month by acting before the Brexit vote, which could then have compounded the impact of the Brexit result. Now that the financial markets have calmed and fears have been somewhat relieved, I think the Fed can look forward to its monetary policy normalization plans.

After all, the June Employment Report showed supreme job growth for the U.S. economy, and marked May's soft data as anomalous. That satisfied a qualifier of our fair Chairlady, Janet Yellen, and makes a Fed action this month or near-term all the more likely in my opinion. There is a window of opportunity here with the economy humming along, stocks at all-time highs and Fed projections for two rate hikes in place for this year. September presents political friction and also capital flow problems for financial markets due to the fiscal year-ends of many money managers. July is thus opportune for Fed action.

If the Fed raises interest rates this month despite market expectations for no action (Fed Funds Futures show a 2.4% chance), it would shock financial markets. Richly valued gold would get a wake up call, and the dollar outlook would change with gold paying the price. Gold prices would likely collapse on a shift in market expectations. Where most market participants see a Fed on hold today, tomorrow they would be reconsidering the path forward.

Precious Metal Securities

07-27-16

1:00 PM

SPDR Gold Trust (NYSE: GLD)

+0.4%

iShares Silver Trust (NYSE: SLV)

+1.8%

Direxion Daily Gold Miners Bull 3X (NYSE: NUGT)

+3.2%

Direxion Daily Gold Miners Bearish 3X (NYSE: DUST)

-3.3%

Market Vectors Gold Miners (NYSE: GDX)

+0.9%

Market Vectors Junior Gold Miners (NYSE: GDXJ)

+1.2%

Goldcorp (NYSE: GG)

+0.6%

Newmont Mining (NYSE: NEM)

+0.3%

Randgold Resources (NASDAQ: GOLD)

-0.2%

Barrick Resources (NYSE: ABX)

+1.7%

Yamana Gold (NYSE: AUY)

+3.7%

Gold Fields Ltd. (NYSE: GFI)

+3.0%

Silver Wheaton (NYSE: SLW)

+0.9%

Coeur Mining (NYSE: CDE)

+1.4%

But even if the Fed refrains from action today, richly valued gold may give way. That is because of what we have seen occurring over recent weeks. Gold has been shedding capital support as investors have shed fear, including fear of the economic outlook, Brexit, etc. If the Fed holds off from acting again this month, low cost capital remains readily available for individuals and corporations in America, and so investment capital flows can run freely toward risky assets and from safe haven stores like gold.

Thus, today, gold may be doomed either way the Fed goes. A surprise rate hike or another pause and gold has cause to decline. I cover gold closely and invite relative interests to follow my business column here at Seeking Alpha.

Disclosure: I am/we are short GDX.

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: My position is through derivatives and is short-term in nature.