Everyone's Scratching Their Head Over Gold

Gold bulls are frustrated with the metals’ lack of follow-through, while gold bears are no longer experiencing the declines seen this past spring. Markets expectations of a tapering in asset purchases by the Federal Reserve proved misguided, while another episode of a US government shutdown leaves questions unanswered. Throughout these events, gold rallied to three-month highs before dropping to three-month lows within less than two months.

So Where’s The Metal Heading Next?
After the Federal Reserve revived gold bulls in mid-September with the surprising decision to hold off from tapering the $85 bn in monthly asset purchases, traders sent the metal back down during the 16-government shutdown. While falling price pressures resulting from weak growth are seen as a positive for gold due to their implications for further central bank easing, the disinflationary repercussions of renewed economic contraction may imply slowing industrial and consumer demand for commodities and precious metals.

Some have attributed the recent decline from the $1360 highs to the FOMC statement’s omission of the reference to tighter financial conditions and the stronger than expected October release of manufacturing ISM report. Some even argued these dynamics re-opened the door for a potential taper in December. This couldn’t be farther from the truth. Any decision to reduce asset purchases before March is highly unlikely.

Here's Why
Despite the drop in US unemployment to 7.1% from 7.9% in January, the fiscal reality remains that the US economy had flirted with a 16-day government shutdown, a last minute hike of the federal debt ceiling and the postponement of these impasses to no later than the first quarter of next year. The impact of the shutdown is estimated to have reduced at least 0.5% from GDP growth. Going forward (at least until end of November), the impact of the government shutdown will continue to distort much of the economic data, including Friday’s release of the October jobs report.

And with economic growth stabilizing anew in China and the euro zone, the combination of positive dynamics in these regions coupled with stagnant growth in the U.S., the case against gold has subsided.

Disinflation Risk
Slowing inflation, or the risk of disinflation, is another growing factor to take into consideration by gold traders. One of the items consistently recurring in the FOMC statements is that “inflation has been running below the [Fed’s] longer run objectives”, which has been a durable supporting point for the hawks.

Policy guidance has primarily focused on a threshold for the unemployment rate, but last month’s comments from Chairman Bernanke suggested setting an “inflation floor” as a “sensible modification to the guidance”. If Fed chairwoman to be Janet Yellen implements an inflation floor, then this could be a successful means of slowing down rising yields as long as falling unemployment is not accompanied by a recovery in inflation. The Fed’s preferred inflation figure, core PCE price index, is near 2½-year lows of 1.2%. Further declines nearing 1.1% could render the inflation forward guidance to become a carte blanche for justifying the longer way for 6.5% rate of unemployment , without fretting about the need for higher interest rates.

Gold and FX traders will continue to hear the endless chorus of conflicting remarks from Federal Reserve speakers, with the hawks arguing for reduced quantitative easing and the doves stating the structural weakness in labour markets is requires a protracted decline the jobless rate before considering any tapering of purchases. The result of these verbal flows is nothing but two-way market to magnify and flatten price trends. But it’s also an opportunity to for gold’s mean reversion to find a positive bias.

Price Outlook
We expect gold to continue lacking a defined price trend into year-end, suggesting any downside movement below $1,300 should likely find support near $1,273-75. A gradual recovery is anticipated to be charted towards the 55-day moving average of $1,347. Prolonged upside is seen capped right below the 13-month trendline resistance at $1,410, which coincides with the 55-month moving average.