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Gold_Looking_for_Direction_Amid_Polarized_Financial_Markets_body_Picture_3.png, Gold Looking for Direction Amid Polarized Financial Markets

Fundamental Forecast for Gold: Mixed

The month of May proved to be a tumultuous one for the gold prices. The first two weeks were marred by the Federal Reserve’s late-April pledge to allow the second round of quantitative easing (QE2) to expire. This stoked fears of imminently rising borrowing costs and led investors to unwind positions financed cheaply through the program to buy a variety of assets, including gold, sending prices tumbling lower.

Downward momentum was abruptly cut short with the reemergence of the Euro Zone debt crisis as a headline theme mid-month. With markets suddenly preoccupied with the prospect of a Greek default and the political wrangling around a second EU/IMF aid package, gold’s safe-haven credentials drove demand higher and prices recovered over three-quarters of their previous decline. Most recently, price action has reflected indecision, with gold treading water below the $1550/oz level over the past five trading sessions and seemingly unsure of where it belongs in today’s increasingly polarized marketplace.

Looking ahead, the path of least resistance seems uncertain. On one hand, the expiration of QE2 is now just around the corner on June 9, hinting that the un-doing of exposure built around access to cheap US Dollar funding ought to resume and take gold lower as it did in the first weeks of May. On the other, an acute downturn in US economic performance – most recently underscored by bitterly disappointing employment figures – and a parallel breakdown in the S&P 500 argue for a kind of risk aversion that makes markets worried that the global recovery has run into a wall with the steady unwinding of monetary and fiscal stimulus. In such a scenario, investors fearful that “paper” profits accumulated in the post-crisis rally across asset classes since early 2009 may now evaporate will look to shift capital into an alternative store of value, making gold an attractive option.

On balance, the re-accumulation of gold ETF holdings over the past three weeks seems to indicate the latter logic is holding sway, hinting the yellow metal is likely to rise if risk aversion returns in earnest. With that in mind, it is important to remember that gold is priced in terms of another go-to safety asset – the US Dollar – whose gains under parallel circumstances are likely to keep the metal’s upside potential relatively capped. The post-QE2 rise in US yields is likely to encourage this dynamic. After all, gold pays no interest at all, so holding even very low-yielding Dollars is relatively more attractive assuming the threat of a catastrophic inflationary debasement of the greenback is of the table (which seems to be the case with QE over and the economy slowing).