Bernanke Doesn't Understand Gold Prices, Yet Gold Climbs on Fed ReassuranceIt’s true that gold is a very fickle metal. Investors look to it as a store of wealth, a safe haven against financial uncertainty and a hedge against the US dollar. Other times, gold is purchased on the back of supply/demand issues or as a buffer in times of geopolitical turmoil. But what happens to gold prices when investors are faced with many of these scenarios at the same time?

The short answer: who really knows!

Federal Reserve Chairman Ben Bernanke sure doesn’t, nor does he think anybody else does. ”Nobody really understands gold prices,” Bernanke told the Senate Banking Committee on Thursday, ”and I don’t pretend to understand them, either.”

While gold does display some outlandish behavior, Bernanke backed his bold statement by looking at the reasons investors look to gold. “A lot of people hold gold as an inflation hedge,” he explained, “but the movements of gold prices don’t predict inflation well.”

So far in 2013, gold bullion is down by 23 percent despite having rallied over the last two weeks. Yet Bernanke has found some comfort in the metal’s marked decline, “suggesting [it] could reflect diminishing concerns over really bad outcomes.”

Leading up to the Congress meetings this week, investors were concerned that the decision to scale back the US Federal Reserve’s stimulus plan was set in stone. However, despite his comments, Chairman Bernanke reassured investors that the Fed will proceed with caution with winding down the stimulus plans, and reassess should the situation call for it. Gold made some gains on Thursday, climbing half a percent to $1,283.80.

Eric Sprott believes in bulls

The Globe and Mail recently reported on a research report from Sprott Asset Management’s Eric Sprott. It outlines why the company doesn’t believe that the gold bull market is over. Like we have all noticed, there have been dramatic declines in gold prices and strong redemptions in physical exchange-traded funds (ETFs), which are potentially pointing to the end of the bull market for gold. However, Sprott’s “analysis of the supply and demand dynamics underlying the gold market does not support this interpretation.”

There are many major gold buyers adding to their stocks, “while at the same time supply is flat or even decreasing, compounding an already vast imbalance,” according to Sprott.

As Sprott has pointed out in the past, there seems to be a “large discrepancy” between available gold supply and sales, which has brought on the conclusion that central banks have replaced their physical gold holdings with paper gold. From here, Sprott believes that such banks are nearing the bottom of their barrel and that the gold market is about to get incredibly tight.

The conclusion he draws in his report is that “after taking a pause, the secular gold bull market is set to continue.”

What will drive up the gold price? 

If Eric Sprott is correct, and the gold market is set to rally, the next logical question is when? Unfortunately, we at Gold Investing News left our crystal ball at home and can’t give you the answer.

However, Jeff Nichols, a long-term precious metals analyst based in New York, is of the belief that the gold bull market is very much intact and has a ways to go. While Nichols expects to see major corrections in the market, they will not necessarily be as steep as the current decline.

One of the contributing factors that he sees as having aided the sharp drop in gold is institutional selling. “Institutional divestment has been fuelled, all along, by the expectation of higher returns in both equity and debt markets and, more recently, despair over gold’s poor performance with initial selling triggering more selling by momentum followers,” he said in a note.

While the motives from institutions are different than central banks and bullion trades, hedge fund managers and institutions “have been persuaded — and have reaped the benefits — of putting their available funds into the markets where they have seen better short term returns, and those which had substantial gold holdings, perhaps held in the big ETFs, have been offloading them as a consequence,” Mineweb writes.

However, it seems that now “those hedge funds managers wishing to switch from gold to equities and bonds have largely depleted their bullion holdings. In addition, with the recent rise in long-term interest rates, the bull market in bonds is probably over — and, though equities, remain strong, some fund managers are wondering just how long the party on Wall Street will last.”

With this shift in attitude, Nichols expects a turnaround and recovery in the price of gold. But like we said, it really is a matter of when.

 

Securities Disclosure: I, Vivien Diniz, hold no direct investment interest in any company mentioned in this article.