Will Gold Be Scared Higher by Bernanke?

In the aftermath of the worst day for the stock market since last November, Federal Reserve Chairman Ben Bernanke is scheduled to testify before Congress on Tuesday and Wednesday of this week. Session woes on Monday have been blamed largely on Italian elections that saw a strong showing by candidates who are thought likely to reverse austerity measures – the fear being that the European debt mess could get messier. Gold, however, as represented by the SPDR Gold Trust (NYSEMKT: GLD  ) , was up nearly a percent as it braces for the next economic catalyst of the week.

In a speech at the University of Michigan in mid-January, the Fed Chair commented that the economy was "not out of the woods yet," and added that we are "approaching a number of other critical watersheds." The message of that speech is that more quantitative easing would be required and that the Fed would stick with its December decision to target a 6.5% unemployment rate before making any substantial changes to the base interest rate, as long as inflation stays in check. If this week's testimony is anywhere from neutral to bearish on the economy, I would expect gold to make a strong showing. The final piece of the puzzle, of course, is that Congress seems no closer to avoiding the sequestration cuts due at the end of this week; all of these factors are bullish for gold.

A new Italian golden age?
While the issues surrounding the elections in Italy have not been put to rest, the uncertainty that is being created is a problem itself. The managing director of Wedbush Morgan, Stephan Massoca, said about the elections: "If someone gets elected who is simply not going to play by the rules, what are they going to do? It puts them in a real quandary here because their financial support, their monetary support is all stipulated by the fact that these austerity programs are going to be in place." Renewed unrest in the Italian economy could upset all of Europe and bring the debt crisis back to the forefront. This type of development is bullish for gold.

What about inflation?
The central reason that gold bulls are such fans of QE3 is that they believe, as I do, that if you print enough money, eventually inflation shows up. Not to be too cynical, but the reported rate of inflation will remain in check for as long as the people who calculate it work for the people who need it to stay in check. Let me be clear that I have no desire to deride the dedicated men and women who work at the U.S. Bureau of Labor Statistics. The unfortunate reality of things, however, is that if you need evidence of inflation, go to the grocery store or the gas pump. Do you remember when $4 gas made news? Seeing that price at the gas station does not even raise eyebrows any more.

There is increasing evidence of dissension within the Federal Open Market Committee about the efficacy of the current course of quantitative easing. A recent piece in The New York Times reports: "An increasingly outspoken minority of Fed officials are concerned that monthly purchases of about $85 billion in Treasury securities and mortgage-backed securities are doing more harm than good. They argue the effort may need to end even before the nation's unemployment rate drops, because it is encouraging excessive risk-taking and could make it harder to control inflation." If Bernanke's testimony shows even a hint that the dissenters are gaining ground, gold may see some real pressure, although this is highly improbable.

Moving up again
The most likely message from Bernanke would be one of non-committal moderation that reiterates the need for continued bond buying. The effect should be positive for gold, particular as we all wait to see if Congress will learn to play nice before Friday. While I am not optimistic that a lasting solution is imminent, an extension is the probable outcome.

GLD Chart

GLD data by YCharts

While GLD has outperformed the major gold miners like Barrick Gold (NYSE: ABX  ) , Goldcorp (NYSE: GG  ) , or Newmont Mining (NYSE: NEM  ) , all four traded higher on Monday. Despite the fact that all three of the miners are down double digits so far this year, there is an argument for miners over the commodity itself. While a big part of the performance issues are driven by higher production costs – Barrick recently reported escalating costs – inflationary pressure taking over from the recessionary ones is bullish for miners. Miners are corporations that can be hit by a recession – be aware of the sequester issue – but if inflation and European weakness are driving gold, so the miners may have a chance to catch up. Overall, before Friday's deadline, GLD is the smarter play, but gold looks poised to go higher from here across all vehicles.

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