Gold bugs | Janet Yellen’s first FOMC meeting

Gold spot contracts 1 week

For an extended period between the start of the Global Financial Crisis in 2008 and when it peaked in September of 2011, the price of gold was on an inexorable rise. This was said to be based on a number of considerations: (1) a fear for the future of the world’s reserve currencies, which were under threat as a result of the crisis; (2) the idea, much promoted by John Paulson, who gained his reputation by carrying out one of the most successful trades of all time when he anticipated the crash in the sub-prime mortgage market, that Quantitative Easing (QE) in the USA would lead to rampant inflation and that there was serious money to be made in buying and holding gold because of this, and (3) the demand for so-called physical gold from counties such as India and China, where there exists a significant cultural attachment to gold both as an investment and for jewelry, and whose citizens were becoming more and more wealthy.

The use of the adjective “physical” to describe gold that is actually handled and used is to distinguish it from the market in gold futures, where investors can buy and sell contracts for the theoretical delivery or acceptance of the precious metal without ever having to worry about having to actually do so. This market, and indeed the exchange market nowadays for spot gold, which is supposed to be for immediate delivery, are not based on actual inventories of the precious metal. Therefore, they can give rise to trade volumes that are almost a figment of the imagination and which, most importantly, can result in the creation of so much virtual gold that the demand for the physical commodity is completely dwarfed.

And this, in our view, is exactly what has happened. It is why gold prices fell so precipitously from September 2011 and why they still have a way to go on the downside.

Gold has been enjoying something of a resurgence lately, due initially to the delay in the economic recovery in the USA that was brought about by unseasonable severe weather, but more recently because of the geopolitical tensions around Ukraine and Crimea. These are now, barring any dramatic happenings, fading in to the background. Gold is also approaching a significant resistance level on the weekly chart (see above). For all these reasons we now expect gold to decline from here.

Janet Yellen’s first FOMC meeting

And has Ukraine and Crimea peaked as a global threat to the markets? We believe they have. The Western world will talk about illegality and will impose sanctions that are pretty much meaningless, and will at the same time ensure that there is no disruption to the supply of gas out of Russia, or that there is any pressing reason for NATO to get involved militarily. As always, these are judgments that are made on the basis of perceived probability, and no one can tell the future.

In the meantime we will be watching for the pronouncements of the new chair of the Federal Open Market Committee, Ms Janet Yellen, when the second meeting of 2014 of that body concludes later in the global day today.