Fed Kills Gold Trade, but Doesn't Bury It

NEW YORK ( TheStreet) -- The Federal Reserve Open Market Committee made it clear on Tuesday that the central bank isn't about to rush to the dollar printing press with another round of quantitative easing, but there is a difference between killing softly and burying the gold trade.

Since the central bank easy money policy was put in place in response to the financial crash, volatility has typified the gold trade. However, in giving the market no reason to believe QE3 is around the corner, the Fed didn't change course. Speculative traders keeping the gold bubble afloat simply expected too much, and too soon, in terms of Fed action.

Consider that just last week when Federal Reserve Chairman Ben Bernanke spoke at an industry conference the markets interpreted his benign words as a wink and a nod that QE3 was on the way. What a difference a week makes. When the commodities trade, specifically, is positioned on a prayer that central bank policy creates inflation that is a danger, said Jon Nadler, senior metals analyst at Kitco.

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"The gold trade is not dead and buried," Nadler said, "but this does show how much of the house of commodity cards is built on pure and simple anticipation, not only of more give from the Fed but that QE would blossom into some inflationary type of mushroom cloud."

The markets seem to conflate any "Fed speak" about accommodative policy -- which could simply refer to keeping interest rates at zero for years -- such as occurred last week, with a green light on QE3.

With the QE accelerator now idling, gold may test trading support levels that take it much lower -- making it a dangerous trade on any simplified "buy on the weakness, QE is still coming" philosophy.

Gold fell to the $1640 an ounce-range on Tuesday, but near-term, downside risk is all the way to $1200 to $1300. Beyond that, Nadler noted that one of the problems with gold is the fuzzy math that is the basis for its valuation. There is no absolute metric, so with mining production costs at $630 an ounce, gold could ultimately be overpriced by almost 50%.

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"If and when it falls to the $1250 to $1400 range, we can say the peak was solidly in and we will be going into some other market than this different species of bull market for gold we've seen," Nadler said.

Nadler sees a potential return to gold as a safe haven, core portfolio holding negatively correlated with equities, rather than as a trade.

"Gold could perhaps be entering a two- to three-year period of sideways to negative returns, not just because the macro environment is shifting against negative real interest rates, but because the battleship of the Fed is turning too," Nadler said.