Is Gold About To Drop Hard?

• Gold usually leads in anticipating monetary policy shifts
• Today's sharp move lower suggests taper is coming soon
• Fed official rhetoric is laying down the groundwork
• Gold could drop to $1500 by year end

The sudden collapse in Gold at the start of week’s trade may be signalling that US monetary policy will begin to tighten into the second half of the year as the Fed begins to taper its ultra easing stance in light of consistently strong US economic data.

On Friday, US NFP data exceeded growth forecasts with payrolls climbing to 943K versus 870K eyed, prior months revised upward and US hourly wages rising 0.4% vs. 0.3% forecast. The data continues to show a steady and robust US economic recovery setting up the stage for a shift in US monetary posture with the Fed first moving to taper its QE program and then perhaps tighten monetary policy via rate hikes. 

While any such action may be months away, the gold market is usually the first asset to anticipate shifts in monetary policy and just as in 2013 when it led both rates and the dollar by six months in anticipating the taper by the Fed, so to it may be signalling a similar shift coming over the next 12 months.

Gold’s crash, which saw the yellow metal drop by more than 4% in a matter of minutes at the start of the week’s trade, could be the technical signal for more hawkish Fed policy and strengthening of the dollar. The shift however may take months to develop as rates remain near year to date lows while the dollar is basically flat against the rest of the G-10 universe. Still, the impulse move by gold may be an early warning sign of change in policy and could be a precursor to a multi-month decline in the yellow metal that could take it to below $1500/oz.

Although  Fed Chair Powell remains unapologetically dovish at the present time, several Fed officials including Vice Chair Clarida, St. Louis President Bullard and Dallas  Fed President Kaplan have recently stated that policy should begin to shift to taper over the near term horizon. Such concerted rhetoric is usually the first step towards a change in policy and could be a hint of things to come.

If US economic growth remains on pace for the next few months, the market’s expectations of a shift in Fed policy will increase significantly. As always, Gold is the first instrument to anticipate this move and could present a very attractive opportunity to move lower. The November 163/160 put bull spread is priced at around 1 offering a 3:1 payoff if the SPDR® Gold Shares ETF (NYSE:GLD), which is currently trading at 164, trades down to 160.00. Given the sharp selloff in the underlying, today’s move may be a signal of a further drop to come. 

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Written By: Boris Schlossberg