Directionless Fed Pressures Gold

NEW YORK (TheStreet) -- In commodities markets this week, all eyes are focused on Federal Reserve Chairman Ben Bernanke.

Investors in gold and other precious metals are looking for clues to determine the next likely direction in U.S. monetary policy. This has been a difficult task of late, given the conflicting messages sent by various members of the central bank. Clearly, there are dissenting views at the Fed with some members taking on a more supportive stance to extend the time frame of economic stimulus while others have suggested there are unintended consequences to these programs and that they should be phased-out.

Unfortunately, Bernanke's initial comments have done little to clear-up this confusion. The Fed chief's semi-annual testimony before Congress produced directionless statements that account for all possible scenarios and favor none. Specifically, Bernanke said that the quantitative easing programs "are by no means on a preset course."

In the most upbeat scenario, consistent gains would be seen in the labor market and consumer inflation would move toward the Fed's target rate of 2%. In this case, Bernanke has said that "the pace of asset purchases could be reduced somewhat more quickly."

Alternatively, the pessimistic scenario would include elements like an elevated unemployment rate (as the Fed's target of 6.5% is still far below current levels). Here, Bernanke hinted that the Fed might be willing to increase stimulus for short periods of time in order "to promote a return to maximum employment in a context of price stability."

Essentially, Bernanke is telling the market that the Fed is leaving all options on the table and that there is no underlying bias for the next direction in policy settings. But while this dependence on future data might seem like an even-handed, prudent approach to dealing with the economy, it does little to guide investors or financial markets as a whole. Of course, this is not the Fed's job but the added uncertainty is putting downside pressure on certain asset classes.

For gold investors, it is important to note that total holdings in GLD have dropped to their lowest levels since the beginning of 2009 (to roughly 935 metric tons). With demand weakening and gold ETFs seeing renewed liquidation, we will need to see a strong physical market in order to support valuations in the yellow metal.

Gold prices have fallen nearly 7% since Bernanke signaled that the Fed was considering reductions in monetary stimulus on May 22. This year, prices have fallen nearly 25%, wiping out more than $60 billion in value in gold-backed ETFs.

The general downtrend seen in prices reflects a change in market sentiment, as investors question gold's historical position as a store of value with stock markets trading near all-time highs and inflationary pressures almost non-existent. Still, the case can be made that gold valuations are in the process of forming a long-term bottom, as demand in the world's two largest consumer markets (China and India) has improved and is expected to exceed what was seen last year.

But with the directionless position shown by the Fed this week, it makes little sense to step into gold markets at current levels. As investors face continued uncertainty with respect to the over-riding stimulus questions, further liquidation is likely as investors look to reduce exposure to unpredictable markets.

The shift toward cash has already begun, with gold prices showing a strong short-term failure at the closely watch technical resistance level at $1,300 per ounce. The SPDR Gold ETF followed suit, gapping through historical supply levels at 124.30, and trading firmly below its 50-day moving average (130.05). Bias remains bearish as long as prices hold these lows, and continued indecision from the Fed looks set to keep markets in this position for a good portion of the summer.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Richard Cox is a university teacher in international trade and finance, focusing primarily on macroeconomics and price behavior in equity markets. His articles appear on a variety of websites, including MarketBulls.net, Seeking Alpha, FX Street, and others. Investing strategies are based on technical and fundamental analysis of all the major asset classes (stock indices, currencies, and commodities). Trade ideas are generally based on time horizons of one to six months.

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