(By Mani) Gold had the correct immediate reaction to the Fed's announcement of additional monthly purchases of Treasuries worth $45 billion to replace the ‘Twist' program.
The yellow metal climbed to $1,723.40 Wednesday, the most expensive since Nov. 30. However, the rally didn't last long as a slow grind higher in gold was the most sensible reaction as the Quantitative Easing, or QE, premium is gradually priced into the commodity.
On Thursday, gold for December futures fell $21, or 1.28 percent, to $1,694.70 after the temptation to lock-in profits led to a gold sell off to a low of $1694.35 overnight. In addition, investors took a cautious stance as they are eyeing negotiations in Washington over a deal to avert the looming "fiscal cliff".
[Related -Greek Voters Say No, Yanis Varoufakis Says Bye—What Next?]
"But despite the decline of as much as $25 in Asia, we don't think the sentiment towards gold has actually turned negative. The move was amplified by the fact that it occurred in Asia, where liquidity is typically an issue," UBS strategist Edel Tully said in a note to clients.
In addition, bargain hunters were quick to step in sub-$1700, with interest to pick up metal at these lower levels quite evident.
"Our flows indicate some reaction from physical buyers in India this morning, although nothing exceptional so far," Tully said.
Meanwhile, there is hardly any follow-through selling interest in early European hours, and participants are expected to hesitate inchasing the market lower after the Fed has essentially just doubled the pace of money- printing.
[Related -Is a Bullish Reversal Brewing for Bond Fund TLT]
There are two important positive elements for gold here. First, the fact that a balance sheet-neutral program is being replaced by outright asset purchases that expand the Fed's balance sheet is certainly a positive for gold. The second being the 6.5 percent unemployment rate threshold implies a 1.2 percent hurdle from the current level.
"With our economists calling for 7.5% by the end of 2013 and 6.7% by end-2014, loose monetary policy is set to remain in place for some time. Accommodative policy regimes, not only by the Fed but by other major central banks as well, provide gold with a strong underlying support," Tully noted.
There have been some bright spots in gold physical demand lately. In India, buying picked up towards the end of November through to the first week of December, as the rupee appreciated in anticipation of a parliamentary vote on foreign direct investments.
The appetite eased earlier this week, with local gold price's essentially flat, just off the recent lows. After a strong November, UBS index of physical flows to India indicate a 25 percent decline versus the same period in 2011, slightly better than the 30 percent drop earlier in the year.
Activity in China has picked up of late – volume on the SGE has been strong since last week, and that appears to be continuing. Physical demand has also been evident out of Europe in recent weeks, although volume is nothing particularly exciting and buying sporadic.
After subdued physical buying out of the US for most of the year, the US Mint reported very strong sales of gold coins last month due to the re-election of President Obama and the growing focus on the US fiscal cliff. However, December is usually the strongest month, but so far US Mint gold coin sales of 29 thousand ounces (koz) worth have had a slow start this year, following robust November volumes.
"Patches of strength in physical demand help somewhat, but the lack of sustainability and consistency means that the overall demand picture for 2012 is little changed. The risk, though, is that should these waves of strong buying continue towards year-end, albeit inconsistently, challenges to liquidity and availability during the holidays could mean a boost to premiums," Tully added.
In the week to Dec. 12, gold ETF holdings fell by 0.12 million ounces (moz) to 88.53moz. Investors liquidated their holdings from NewGold (JSE) and GBS (LSE) funds by 76koz and 53koz respectively. Julius Baer and DB physical gold funds were down by 7koz each. On the contrary, iShraes fund was up 14koz, and small inflows came in ZKB fund. Total ETF holdings are up 0.04moz, month-to-date.