Ben Bernanke the two of us need look no more. We both found what we were looking for: QE3

Contract gold dropped to below $1,620 an ounce ahead of a crucial policy statement by the Federal Open Market Committee that will be released on Wednesday after two days of deliberations.

Gold bugs are waiting with bated breath for news that the Federal Reserve and its Chairman Ben Bernanke have agreed to further asset purchase programs to follow the first two rounds of quantitative easing and the so-called Twist program that is set to expire at the end of the month.

Quantitative easing has been a massive boon for gold with the price almost doubling on the back of QE1 which kicked off in December 2008, QE2 (first mooted in August 2010) and 'Operation Twist' (started in September last year). Before QE1 the Fed's total assets were below $1 trillion. It is now closer to $3 trillion.

If the Fed stops flooding markets with cheap money, gold’s allure as a storer of wealth and an inflation hedge is tarnished. Tighter monetary policy also strengthens dollar, further hurting the yellow metal.

MarketWatch quotes BNP Paribas precious metals strategist Anne-Laure Tremblay who believes if not now, "probable" future interest rate cuts by the European Central Bank, the People’s Bank of China and QE3 by the Federal Reserve will support improved prices for gold through 2012 and into 2013.

Reuters spoke to Lynette Tan, an analyst with Phillip Futures in Singapore who warned that if the Fed does not announce any new programs gold will likely start falling again: "For the moment, we expect policy decisions from the Fed to influence gold price more than risk appetite linked to the euro crisis."

Nigam Arora of The Arora Report has some advice on how to capitalize on the outcome of the meeting: "Since after the Fed statement trading can get volatile, it is best to trade only those instruments with tight bid and ask spreads such as gold ETF, silver ETF, gold August futures, and silver July futures."

 

 

After hitting a high for the year, but failing to scale the $1,800 an ounce bar at the end of February, gold has taken a few hard knocks on the way to its current trading level.

The spikes downward have all been thanks to actions or pronouncements by the Fed and the fortunes of the precious metal seem increasingly linked to monetary policy in the US. At the same time volatility in the gold price has increased dramatically.

At the start of April for instance gold dropped some $60 an ounce in a single session when Fed minutes appeared to indicate QE3 was off the table and its policy of zero interest rates may be coming to an end sooner than previously thought.

The same thing happened on June 7 when gold dropped $50 to under $1,600 an ounce in a couple of hours after Bernanke delivered "anti-climactic" testimony to the US Congress.

That was not the first time traders got cold feet after breaking an important psychological level. A similar pattern was followed in the days after gold futures hit a record high above $1,900 an ounce in August. The yellow metal slid for two days after hitting the record, losing $105 or 5.6% in value in a single day.

In 2011 trading in gold was the most volatile since 1980 with the gap between the year’s highs and lows coming in at close to $600 an ounce or a 32% range.

In 1980 the spread was even greater at more than 40% and followed the 21 January 1980 record of $850 a ounce set after a spike in oil prices following the Iranian revolution and Russia's invasion of Afghanistan.

At the time gold also fell precipitously after setting the record – within two days it fell back to under $700 starting a bear market that lasted almost three decades.

Gold breached $850 again at the start of 2008, but in inflation adjusted terms the 1980 price is still the highest ever – gold would have to hit some $2,400 an ounce to set a record in today's money.