HardAssetsInvestor

Written by Sumit Roy  |

June 19, 2012

Fed Action Could Spur Huge Volatility In Gold Prices; Here Are 3 Possible Outcomes

Details

We offer our latest analysis on the precious metals market.

This past weekend’s parliamentary elections in Greece promised to be a major mover for risk-asset prices, including gold. Yet, the event has come and gone and the aftermath has been relatively underwhelming.

As most would have expected, stocks rose, albeit modestly. Gold, however, hasn’t done much at all.

We saw a positive outcome in the Greek elections. Pro-bailout factions received enough votes to form a ruling coalition, ensuring that Greece will remain in the eurozone, at least for now. The worst-case scenario of a Greek default and exit from the eurozone was averted.

In and of itself, that is bearish for gold, which had rallied recently on the back of safe-haven buying. Even so, that the eurozone sovereign debt crisis is far from over. Another spike in interest rates on Spanish debt provided a stark reminder of this.

The 10-year yield touched 7.29 percent on Monday before backing down slightly.

Yet, as we’ve written in recent weeks, the events in Europe are only indirectly influencing gold prices. Rather, we’ve characterized the yellow metal as essentially a bet on forthcoming stimulus from the Federal Reserve.

Anything that increases the probability of another round of QE3, for instance, is bullish for the metal, while anything that decreases the probability is bearish.

On Wednesday, the U.S. central bank will unveil its latest monetary policy decision, potentially setting off significant volatility in gold prices.

But a day ahead of that decision, uncertainty reigns. Analysts are split on whether the central bank will take any action, with some expecting an extension of Operation Twist (which expires at the end of the month), others expecting stronger action in the form of quantitative easing (QE3) and still others expecting the Fed to do nothing. Here are how we see those three scenarios playing out:

1. A mere extension of Operation Twist—in which the Fed replaces its short-term maturity Treasury holdings with longer-term maturities—is unlikely to be enough to spur a large, sustainable rally in gold prices. Expect prices to stay within their recent range in this scenario.
   
   
2. No action would be extremely disappointing for gold bulls and may lead to a retest of the key $1533 support level.
   
   
3. Only a third round of quantitative easing (QE3), whereby the Fed would expand its balance sheet, is likely to spur significant buying in gold. Indeed, such an outcome would be extremely bullish and be an immediate buy signal. Depending on the size of the Fed’s program, gold could make a run for its record high above $1900.
   
   

Currently, from a technical perspective, gold remains locked in a band between $1540 and $1640. A breach of either level would be a signal to sell or buy, respectively.

GOLD

SILVER

PLATINUM

PALLADIUM