Caution ahead of the Fed

With all the hype preceding this week's Fed meeting, not to mention the usual circus atmosphere surrounding some potential action from the ECB, my advice to both gold and silver traders is to be EXTREMELY CAUTIOUS. The market has worked itself into a tizzy in my view as it salivates at the further prospect of additional liquidity measures being undertaken by both Central Banks.

When markets are in this state of mind, you will end up either being a HERO or a ZERO. In other words, you are now in the precarious position of having your fate determined by the roll of the dice. If you get it right, and the Central Banks act when you expect them to, you will be a hero. If you get it wrong, and the Central Banks disappoint, you are dead meat. Frankly, that is not the way to be a long term survivor in these markets. Yes, you may hit it big and congratulate yourself but what happens if you miss???

Personally I do not believe Bernanke has the appetite to go with another round of QE at this time. Maybe in September but not now. Why? Simple - look at the current yield on the Ten Year:

Do you really think that the problem with the economy is that longer term yields are not low enough to stimulate borrowing? How much lower do you think that the Fed might be able to drive this yield by launching another round of bond buying? Perversely enough, if the Fed were to actually pull the trigger, the market will probably do the exact opposite with Yields moving HIGHER instead. After all, yields are moving lower or stuck near historic lows because the market fears the fallout from excessive amounts of debt in the system which is weighing on global and domestic growth. If the psychology were to somehow shift to fears of inflation, yields on this Ten Year will start moving higher. That would actually short circuit any attempt by the Fed to push yields lower so as to stimulate new borrowing.

My own view is why mess with bond buying programs if the market is already doing the work for you on its own?

Then there is the level of the S&P 500. Does this look remotely like a market that is serious trouble??? While we technicians can pour over our indicators and study the internals of this market like the soothsayers of old studied the entrails of slaughtered sheep, the average Joe looks at his stock portfolio and basically yawns. Now, if the S&P 500 were flirting with the 1000 level, this would be a different story; however, as with the yields on Treasuries, why mess with things if the market is doing what you want it to do without taking any additional steps such as another round of bond buying?

Keep in mind that Central Bankers will ALWAYS RESORT TO VERBAL INTERVENTION first to see if that can accomplish their intentions without having to resort to the actual intervention. The latter will proceed only if the market calls their bluff on the former. At that point, in order to preserve their credibility, the CB's will then act.

Think about what the Fed has managed to do thus far (and we might add the ECB which is now getting into the game). They have driven yields down to historic lows and the stock market to not far from its all time high without having to engage in another round of politically toxic Quantitative Easing. Why should they proceed this month with plans to start another round forthwith?

My view is that they will do nothing except more of the same - namely - tell the markets that they are monitoring the economy closely and stand ready to act should the conditions warrant. That is what is so perverse about this stock market rally - the disconnect from stocks and the actual economic conditions is becoming more and more strained with the passing of each week.

As the economy continues to slow the stock market has continued to shrug off each new release of economic data confirming the slowdown. The entire rally has been predicated on the supposition that the rotten economic data will surely force the hand of the Fed to act. But put yourself in Bernanke's place and try to see it through his eyes.

WHo is calling the shots here - the market or the Fed? If the Fed is seen as nothing else but an errand boy of the markets, acquiescing to its demands come hell or high water, then what good is the Fed? After all, if the market determines Central Bank responses, then why have a Central Bank at all? Why not merely take a poll among the investor/hedge fund camp and see what they want and just have it implemented by the Fed? Basically we end up with the situation where the markets say "JUMP" and the Fed responds by saying "HOW HIGH?" Personally I do not think Bernanke is going to allow this to happen.

Now, if the market were to suddenly collapse and a selling rout occur across all asset classes, then the Fed would act.

Of course, the Fed could surprise everyone and announce this week another round of QE which would have serious implications as far as food prices would go. With grains being devastated by the drought and reaching historic highs, a new round of bond buying would send more hot money flows into the commodity sector in an even larger way and would drive prices even higher for a short time. I suspect that it would also shut off demand but for the very short term, it would send shock waves through the food supply chain.

I have said all this to merely emphasize the point, gold traders and silver traders for that matter, be careful out there. It is not the time to play reckless. The market will always be there tomorrow should you miss a move today. Remember that.