By Greg Peel

Investors stilled shocked at the sudden big move down in gold last night might be able to point the finger at a very large US Treasury futures sell-order which hit the market shortly after Fed chairman Ben Bernanke began his testimony to the House Financial Services Committee.

Bernanke's testimony caught traders by surprise given a seeming element of contradiction. The world has been watching as successive US economic data releases have pointed to an economy finally on the mend, and indeed the Fed's anecdotal Beige Book survey, released post-testimony, affected an upgrade in assessment of economic growth from "modest" to "modest to moderate". Yet Bernanke remained cautious.

While the employment climate appears to be slowly improving in the US, Bernanke rightly pointed out that the trend was not yet flowing through to final demand. Remembering that the US economy is dominated by domestic consumption, evidence has pointed to inventory builds stemming from increased production with a flow-through to actual consumption not yet apparent. The risk here is that producers have become overconfident and will find themselves stuck with unsold stock.

Thus one could call Bernanke's testimony more "downbeat" than "upbeat", which would, under normal circumstances, explain the fall in stock prices overnight. However that is not the reason stock prices fell. Despite Bernanke's caution, his conclusion was that current levels of monetary stimulus could justifiably be maintained. These include QE2 rollovers, "Operation Twist" and zero rates out to 2014, all of which is sometimes referred to as QE2.5. But that's not what Wall Street expected to hear, especially if Bernanke was being more circumspect about current US growth.

Wall Street expected to hear that the Fed would do more if it had to to, and always stands ready to pull out all stops. In other words, the Fed never uses the expression "QE3" but Wall Street had assumed that appendix would again be provided as it has been now for many months. Yet Bernanke was only implying he could not see the need yet to pull back on QE2.5. Suddenly QE3 has disappeared.

Is it because the US economy is looking a little better, if not wildly so? Is it because Greece has now been rescued and Europe has settled down once more? Bernanke is not one to choose his words indiscriminately, and possibly chose to simply omit talk of QE3 and leave traders guessing rather than to bluntly declare its withdrawal from the Fed agenda ? a move which may well have sparked a far more severe response. But as it appears, someone took the news as a signal to make a very large change in portfolio stance.

News wires are running hot with the news that minutes after Bernanke began his testimony last night, an order to sell 100,000 US Treasury futures across several longer-dated maturities hit the screens and caused all sorts of mayhem and speculation. Orders of 5,000-15,000 are the norm at the "big" end. Was this a "fat finger" error, or was this for real?

Compounding the confusion was an immediate rollover of all those contracts, sold in the March expiry contract, into the June expiry contract. Traders saw this as a likely, genuine error, in that the order was meant to be for June contracts all along. But was the size an error too? The CME noted no erroneous trades were reported and no trades have subsequently been cancelled.

US Treasury bond yields have been trading at often record low yields across the curve for the past several months, reflecting America's lesser-of-the-evils safe haven status, the ongoing reluctance to buy shares, and the assumption QE3 was either nigh or at least ever-ready. This futures order seems to imply a large fund manager has decided to significantly reverse a bond position based on a new expectation that QE3 is now back in its box.

The yield on the benchmark ten-year Treasury spiked a full six basis points to 1.99% in the minutes following the order's placement and largely there remained. That's a big sudden move for the world's most liquid market.

Also complicating the matter was the slightly larger than expected take-up of the ECB's second Long Term Refinancing Operation by European banks, which sent the euro on its biggest drop for quite a while, at 1%. This put upward pressure on the US dollar index but currency markets were just as confused as bond markets when the big bond order was placed. And a combination of all of the above meant those shorter-term, more nervous gold traders decided they'd better get out now, and fast. When such selling occurs, your longer term gold investors tend to stand well aside and let it happen.

Gold bugs enjoy such selling because they are perennial long term bulls and like the opportunity to top up on any pullbacks. As to whether last night's near US$100/oz plunge in the precious metal implies a structural shift down to lower levels, now that QE3 may be off the table, or simply an overreaction, we'll need to let the dust settle first before deciding.

But realistically, the ECB stepped up quantitative easing last night through its LTRO, the Bank of Japan has been hard at it, the Bank of England has increased its QE and while the Fed might not, at present, see the need for QE3, QE2.5 is substantial and easy policy will remain out to at least 2014.

There are still plenty of gold bulls out there.


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