Gold Bounce is Illusory

Last week, gold prices bounced as the FOMC statement came in more dovish than anticipated.
In response, interest rates fell, stocks moved to new highs, the dollar declined, and commodities
bounced out of deeply oversold states. Much of the move higher came due to bearish
sentiment and high levels of short interest being unwound.
Many are interpreting the advance as some sort of meaningful inflection point, I believe this is
merely an oversold bounce that is due to rollover. It is certainly true that conditions are similar
to previous bottoms such as a retest of lows with technical divergences, extreme bearish
sentiment, and a capitulation like feel to the price action. Additionally, the violent bounce higher
also mirrors the powerful, early stage advances when assets bottom.
However while these factors are necessary for a bottom to form, they are not sufficient. Over
the long term, the fundamentals determine major directions. The fundamental case for gold
remains broken. Further, the technicals reveal that gold is vulnerable to a major move lower.
Monthly Chart

The monthly chart above shows that after falling 40% from its peak, gold has been range bound
since mid 2013. Ironically, golds decline took place over QE3 which was open ended to the tune
of $85 billion a month, and its fall was halted when the Federal Reserve began openly
discussing tapering its purchases.
Of course, one cannot draw causality between these events, however it does show that the gold
bull argument of expansionary monetary policy being bullish for gold is flawed. The inflation
predicted by skeptics of monetary policy has not been realized. Further, while inflation remains

docile, short term rates are headed up. This is an unusual combination - rising short term rates
and weak inflationary pressures - both are bearish for gold prices.
Improving Financial Conditions
Overall, this reflects a situation in which financial conditions have remarkably improved to the
extent that monetary policy is being normalized. While the Fed came out slightly more dovish
than expectations on Wednesday, it did not budge from its path towards hiking rates, merely the
speed of this path.
At this point in time it is a near certainty that rates are going to rise. In terms of expectations,
markets are already pricing it in. The Federal Reserve is well aware of its impact in terms of
affecting monetary policy via expectations, so it is only tolerant of rising short term rates in
anticipation, if it were its intention. Rate rises are so bearish for gold, because it imposes a cost
of ownership for zero yield assets like gold. Symbolically it is even worse.
Needless to say that gold prices thrive in periods of financial instability and inflation or
expectations of inflation. Financial conditions have improved enough to the extent that the
Federal Reserve has been marginally tightening monetary policy via tapering and ending asset
purchases for more than a year. Additionally, the macroeconomic factors driving the dollar
higher is of course bearish for gold priced in dollars.
In one sense golds performance during its sideways trading range is quite impressive given the
strong move in the dollar, decline in inflationary pressures, and improvement in financial stability
as measured by stress measures. Such relative strength with improving fundamentals could be
the seeds of a bull market out of a long term base.
Conclusion
Given the deterioration of the fundamentals, this sideways range has the potential to be
overhead resistance leading to heavy selling pressure. As the monthly chart shows above, gold
has the potential to fall hard as little support was built on the way up. Additionally, the technicals
set up an interesting short opportunity with a break below the November lows of $1140 which
has the potential to create a torrent of selling.
Gold is a psychological asset which generates no income, thus it is prone to overreacting on the
downside as well as the upside.