The looming Fed decision on Wednesday has many market watchers on the edge of their seat waiting to see what happens with the outcome of the taper debate. Some are calling for a big reduction in the asset purchase programs, while others are forecasting a more modest slowdown.
The final decision will ultimately play a huge catalyst in the future price trend of stocks, bonds, and commodities. But one asset class that will certainly see some additional volatility in the weeks ahead is gold.
We saw the SPDR Gold Shares ETF (GLD) fall out of favor in the beginning of the year and decline precipitously until it bottomed in July. Since that time, a snapback rally alleviated some of the downside pressure but this fledgling uptrend may be facing its most critical test in the near future.
In my opinion, GLD needs to hold the $125 level in order to retain its technical strength and continue to gain additional steam. If it can form a higher low and blast off above its August high, then we may see a run for the 200-day moving average (red line) which would bring additional asset flows back into this sector.
The Bull Case
The Fed may ultimately be the catalyst that sets this precious metal on fire as Ben Bernanke’s comments generally tend to fuel speculation about inflation, currency risks, and economic growth potential. These are all key elements in the fundamental case for owning gold along with the safe haven aspect of a hard asset in favor of paper stock or bonds.
If we see a misstep by the Fed this week that sends stocks lower, then we may witness a flight to quality back into GLD and other precious metals ETFs. Another supportive factor in the gold debate is the deterioration in the U.S. dollar index which has been under pressure since the July low in gold. A weaker dollar is typically bullish for precious metals.
The Bear Case
On the flip side, Goldman Sachs recently forecasted that gold would fall to new lows on the back of a fresh acceleration in the U.S. economy in 2014. There is certainly a case for this to occur if the Fed gives the market what it needs and we see a liftoff in stock prices. This scenario would likely negate the safety trade in gold and lure risk takers back into stocks and other high yield securities.
In addition, we have continued to see unabated asset outflows from gold-related ETFs in 2013. According to Index Universe, GLD still tops the list of total redemptions with over $20 billion in outflows this year and has lost over $400 million in September alone. Clearly this is a sign that investors have used the most recent bounce to continue exiting their gold holdings.
How To Play Gold Right Now
While there are definitive arguments for and against owning GLD at this juncture, I am in favor of looking at it from a risk to reward standpoint. If you currently own this ETF, then I would continue to maintain the position with a conservative stop loss to limit your downside risk. That way you won’t get heavily burned if the Fed statement sends this fund sliding back down to the lows. Remember to size your position in line with your risk tolerance and not to get too overly allocated to this sector which is a mistake that I often see made by overly enthusiastic precious metals investors (i.e. gold bugs).
If you don’t have a position in GLD but are considering making an allocation, I would wait until we get more clarity in the coming days and the price trend makes a turnaround. I don’t think that there is a definitive edge to jumping into this ETF ahead of a known event that could send it careening in either direction. Keep some dry powder on hand if we start to see renewed strength emerge and start with small positions as you make your way into this sector. Without a doubt there will be continued volatility in the coming days and you may be able to use that to your advantage as you work into new holdings.
David Fabian is the chief operating officer at Fabian Capital Management LLC.