Hawkish Fed, weak Chinese demand sink gold price

Gold gave up more than $25 an ounce to a week low on Thursday, after the Federal Reserve decided to keep stimulating the US economy, but hinted that tapering of the program could still happen this year.

In lunchtime trade on the Comex market in New York December gold futures changed hands at $1,320.90 down $28.40 or 2.1% from yesterday’s close and at the lows for the day.

Volume was brisk and by 1pm EST the number of December gold contracts changing hands already stood at 130,000, compared average daily volumes on the exchange of less than 170,000.

As widely expected, the Fed voted 9-1 on Wednesday to continue monthly asset purchases of $85 billion a month, but adopted a slightly more positive stance on the health of the US economy.

The US central bank left the door open to start throttling back the quantitative easing program that is set to top $4 trillion by the end of the year when it next meets in December.

The open-ended QE program has been a massive boon for gold which benefits from a weaker dollar and an increased risk of inflation that all the easy money being poured into financial markets create.

But the more hawkish stance by the Fed has already seen the US currency jump to a two-week high on Wednesday. The QE program effectively created a floor for the gold price which is down some 20% this year and cutbacks would eliminate a major factor keeping the metal from falling further.

Reuters quotes Afshin Nabavi, head of trading at Switzerland’s MKS as saying the Fed managed to surprise bullish gold traders:

“The market was long pre-announcement, and the Fed’s wording brought along some stop selling. The market I believe was expecting a more dovish tone.”

Another factor depressing sentiment was weakening Chinese demand, which is expected to take up any slack from India, traditionally the number one consumer of the metal.

For the better part of a year, Chinese buyers were willing to pay more for gold than investors in the West as evidenced by premiums on the Shanghai Gold Exchange.

From zero in October 2012, premiums to the London gold settlement price reached $10 an ounce before April’s gold price plunge and then shot up to more than $20. Gold’s second gap down in late June to below $1,200 saw Shanghai premiums top out at $37.

On Tuesday gold traded at a discount in China for the first time in more than a year and since then has only improved slightly to a $1 premium.

Australia’s ANZ Research argues on Thursday in a note that “the slowing of physical demand and decline in Shanghai premiums will mean gold prices will have to fall further before sparking any strong end-user demand.”