SideNote: We now know that the Federal Reserve decided yesterday to Leave Rates Unchanged. In my view, SK Options makes the best case for buying gold. GRIM

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Gold Has Passed the Lows
SK Options Trading
January 18, 2016

We preface this article by stating that we are neither gold bears nor
bulls. We traders and we target trades with the best possible risk
reward dynamics, regardless of market direction.

We believe we have seen the lows and are preparing to get long gold once again

In December 2015 the Fed raised interest rates for the first time
since 2006. This began a new tightening cycle and was accompanied with
overall hawkish sentiment and dot projections that indicated the Fed
expected another 100 basis points of hikes would be required in 2016.

This was the most hawkish monetary policy since action taken in nearly
a decade and should have been heavily bearish for gold. However, the
yellow metal failed to break through support at $1050 and did not even
challenge the longer term support level of $1030.

At the beginning of this month the employment report showed that
nonfarm payrolls had increased by a considerable 292,000 and that
previous two prints were revised upwards by 50,000 new jobs. This is
the type of improvement in economic data that the Fed would use as
good reason to hike rates again. Therefore the print should have sent
gold lower, as it made further hawkish action more likely. Yet, gold
maintained its strength on the print and has failed to break support
at $1080 in the week since.

The next $100 move in gold is higher, not lower, and is likely to take
place inside the next two months. This means that the medium term lows
are in and that it is time to get long gold.

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Dovish Fed to Send Gold Higher
SK Options Trading
January 26, 2016

Gold and US real rates have long had an inverse relationship. Gold
rallied to all-time highs while monetary policy was being made
historically accommodative through quantitative easing. Then, as these
measures were reduced and the Fed moved towards the beginning of a new
tightening cycle a bear market in the metal began, leading the metal
to almost halve from its prior highs.

However, gold failed to break to new lows when the Fed announced their
first rate hike in December. When new employment data in January
showed continued strength in the economy, making future hikes likely
to come sooner, the metal again failed to break lower. Financial
market mayhem has now made it highly unlikely that there will be more
hikes in the medium term, which means that gold has no catalyst drive
it lower. Instead, we believe that gold is in fact likely to have a
major bullish catalyst this week: The Fed.

Why The Fed Will Not Hike

The rate hike last month was regarded by many, including us, as the
beginning of a new tightening cycle for the Fed. However, since then
we have seen market concerns around China's currency devaluation and
the future of the inflation situation escalate significantly, leading
to mayhem in the financial markets.

This turmoil alone is enough to stop the Fed from hiking again. During
the correction last year the Fed chose to not hike rates at their
September meeting. The Fed reinforced that the tightening of monetary
policy would be with respect to market sentiment with this decision.
Investors were assured that the Fed would keep monetary policy highly
accommodative and that tightening would be gradual.

This means that the Fed cannot hike during times of tumult in the
markets as to do so would cost them credibility, and thus their
ability to signal to their intentions. Therefore, it is near certain
that the Fed will choose to leave interest rates unchanged at their
meeting this week.

Disinflationary Pressures Will See a Dovish Fed

While China’s currency devaluation should not directly affect the
Fed’s monetary policy decision, the effects of the devaluation will.
The weakening of China’s currency means that other currencies, and in
particular the US dollar, are now stronger. This means that US exports
are more expensive, which makes them less competitive. The result is
that economic growth in the US has the potential to be severely hurt.
If growth begins to slow, inflationary pressures will fall also.

The continued decline in oil is having an increasingly negative
effects on the energy sector. A lack of expansion in the energy sector
means that support companies, such as the industrials, are similarly
hurt. The total flow on effects of this mean that the decline in oil
is now having a considerably negative effect on the economy

Without concerns around the future of the inflation situation the Fed
has the option to take a dovish stance. However, this is not the only
reason that they are likely to do so. Credit spreads have widened,
which means that interest rates are effectively higher without a hike.
This means that the need to raise rates now to combat future
inflationary pressures has been significantly reduced, as the higher
borrowing costs will have a similar effect that of a January hike by
tightening financial conditions.

Considering the combined impact of both a disinflationary outlook and
wider credit spreads increasing borrowing costs, we can see that the
Fed is likely to take more dovish action than simply leaving rates
unchanged. To ease concerns around inflationary pressures and to
lessen the negative impact that wider credit spreads will have on
inflation, the most prudent monetary policy action is to provide a
dovish statement following this meeting.

What this Means for Gold

Given the long term inverse correlation between gold and US real rates
and our view that the Fed will release a dovish statement this week,
we gold is highly likely to rally. The question is, by how much?

If the Fed releases a dovish statement, as we expect that they will,
then the rally in gold is likely to be substantial.

Adding to this bullish effect from the Fed is the fact that gold is
underpriced relative to bonds at this point. SHY, the ETF that tracks
1 to 3 year Treasury bonds, last closed at $84.75. This level
corresponds to roughly $1150 gold, but the yellow metal is currently
trading $40 lower. This means that even without a dovish statement
from the Fed, gold has the potential to rally to at least $1150.
Therefore we believe that gold has considerable upside potential from
here and high probability of achieving it.

http://www.skoptionstrading.com/updates/2016/1/26/dovish-fed-to-send-gold-higher.html