Near record shorts could set up huge Fed gold price surprise

The fear trade

The gold price suffered a mini-selloff on Tuesday, a day before a decision by the US Federal Reserve on whether to start tapering its economic stimulus program.

On the Comex division of the New York Mercantile Exchange, gold futures for February delivery last traded at $1,233.10 an ounce after falling by more than $14 during the regular trading session.

The Federal Open Market Committee on Wednesday could announce a reduction in purchases of $10 billion – $20 billion under its quantitative easing program at the conclusion of a two-day meeting that started today.

The Fed has been reviewing QE and is eager to throttle back asset purchases running at $85 billion a month that has pumped $4 trillion of easy money into the US economy since the program kicked off in December 2008, when gold was trading at $830 an ounce.

Forecasts of the Fed’s timetable and size of cutbacks vary widely with a Reuters poll showing only 12 out of 60 economists predict a taper this week and a small majority believing cuts will only come in March.

While some observers believe the impact on the gold market of the eventual QE taper announcement would be minimal as the news is already baked into the price, others see a rally if the taper is delayed further or a fall to 2013 lows below $1,200 if Ben Bernanke and co surprise the market.

A wildcard for price action in gold is the near record number of large investors holding short positions – bets that the price will decline.

While short positions held by managed money fell by more than 6% to 74,312 lots in the week to December 10 according to Commodity Futures Trading Commission data released Friday they remain within shouting distance of the more than 7-year high above 80,000 lots reached the week before.

So many big players short of gold could translate into further upside for the metal as commercial traders are forced to cover their positions ahead of year-end closeouts if the gold price should react positively to the Fed announcement.