How to Take Advantage of the Confusion Created by the Federal Reserve

Guest post by Investment Contrarians 

Over the last few days, the level of confusion regarding monetary policy by the Federal Reserve has increased substantially. The result has been that buyers have re-emerged in the gold market. 

First there was the release of the minutes from the last meeting of the Federal Reserve on June 18-19. The information was confusing because the language used by the Federal Reserve caused some people to question the timing of their reduction of monthly asset purchases. 

While the Federal Reserve minutes stated that “many” members of the Federal Reserve required an improvement in the jobs market before any reduction in stimulus would begin, they also reported that half of the Federal Reserve members thought that they would begin reducing the asset purchase program by the end of the year. (Source: “Minutes of the Federal Open Market Committee Meeting,” Board of Governors of the Federal Reserve System web site, last accessed July 11, 2013.) 

After the release of the minutes, Federal Reserve chairman Ben Bernanke was speaking in Massachusetts and offered more insight by stating that he believes the current accommodative monetary policy by the Federal Reserve will remain in place into the near future. 

This exemplifies the confusion that even the members of the Federal Reserve are facing. It’s becoming clear that the members of the Federal Reserve are no better at predicting the future than anybody else. So when the Fed chairman expressed his view of a continuation of current policy, gold bullion moved up sharply. 

As a group, investors tend to overreact, and that tendency can be obvious in the markets. Gold bullion is a great example of the market swinging like a pendulum from over-optimism to over-pessimism. 

Featured below is the chart for the spot price of gold bullion:

Chart Courtesy of www.StockCharts.com 

The gold bullion market has been extremely volatile this past year. I think the most important points to remember when dealing with the gold bullion market is to be flexible and not fall prey to getting caught on an emotional rollercoaster. 

The recent move downward in the price of gold bullion from $1,800 an ounce to below $1,180 is huge considering the drop’s short period of time. As investors started pricing in a reduction in asset purchases by the Federal Reserve, they went too far in extrapolating the impact on many markets, such as gold bullion, and essentially threw the baby out with the bathwater. 

Even before the recent comments by the Federal Reserve chairman, the price of gold bullion over the last few days has been firming up. It appears that the gold bullion market is now minus the large number of sellers that we have witnessed over the past few months. 

While no one can predict the exact bottom or top for gold bullion, what I would suggest is to have a longer-term view and use this framework for both adding to positions when people panic-sell and taking some profits when people panic-buy. 

With the price of gold bullion just above the level at which most miners can produce gold bullion before incurring a loss, there is some sense of a floor being formed. If gold bullion were to break below $1,000 per ounce, for example, we would see many mines shut down, curtailing gold bullion supply. As long as demand remains stable on the margin, that would help the long-term pricing of gold bullion. 

Of course, over the next few months, the actions of the Federal Reserve will be quite important not only for gold bullion, but also for stocks, bonds, and currencies. If the U.S. economy continues improving, it will certainly induce the Federal Reserve to begin reducing its asset purchase program. 

But if the data turn negative, then the Federal Reserve will simply have to push back its timeline for when to begin adjusting monetary policy. 

Pay attention to the data and watch for over-sold and over-bought conditions across all markets.

~ by Sasha Cekerevac, BA 

This article How to Take Advantage of the Confusion Created by the Federal Reserve was originally published at Investment Contrarians