Bring it on Bernanke!

It’s an all too familiar theme at present. The market shoots up 1-2% one day, only to retrace the gain the following day. The simple fact of the matter is that the market is undecided between the double-dippers and those that see an, albeit gradual, recovery. Market indecision manifests itself in increased volatility and that is what we are seeing now.

Monday’s strong gains were driven by renewed optimism with regards to the likelihood of a US double-dip recession. This came on the back of Federal Reserve Chairman Ben Bernanke’s conference speech the previous Friday. Bernanke conceded that the recovery was not progressing at the pace he expected. He would of course have been hard pushed to say anything else given the downgrade to second quarter US GDP from 2.4% to 1.6%. Not to mention the particularly poor US housing data released last week.

Nevertheless, it isn’t so much Bernanke’s observations that interest the market, but when and how he might turn his words into action. On this front he was reasonably clear. He does not believe that a double-dip US recession is likely, expecting instead that modest second half growth will begin to accelerate next year.

He is talking his own book though and it would be a rare Central Banker that decided to engage in the kind of scaremongering that is presently evident across the media. Even so, he backed that comment up with the statement that the Fed was not out of ammunition and stood ready to act if his positive outlook does not come to pass.

The Fed’s ammo box may be a little light in terms of further interest rate cuts, but it can still extend the effectively zero interest rate environment for much longer than the market currently anticipates. The Fed also has a remarkable weapon called a printing press that has an almost infinite ammunition resource. Bernanke stands ready to deploy this through further US Treasury purchases, launching a wave of liquidity against any approaching deflationary tide.

There’s really little surprise in Bernanke’s comments. His view that the Great Depression could have been prevented had the central bank flooded the system with liquidity is widely known. Indeed, his overall bias towards accepting temporarily higher inflation and reduced purchasing power for the Greenback to maintain growth is central to our bullish view on gold.

The US market fell overnight on the back of a smaller than expected rise in personal incomes. The US is predominantly a consumer based economy and an active consumer is absolutely necessary for the recovery. Healthy personal incomes are obviously a driving force of consumer spending and if that is in doubt, then so too is the likely pace of recovery.

The level of personal income is however still rising and as the table above shows, the savings rate actually declined marginally last month. The main driver of all this is of course unemployment, so Friday’s jobs data was closely watched. Expectations are for around 100,000 job losses but in the event the figure came to 54,000 which caused market's to rally.  Furthermore, private employers added 67,000 workers which was clearly a positive sign.

The economic picture in the UK appears somewhat brighter than in the US although recent data has been mixed. On the one hand economic growth for the second quarter (the three months to the end of June) has been revised up to 1.2% from the previous figure of 1.1%. This follows a sharp upward revision of the estimate for the construction sector where growth game in at 8.5%. The services sector meanwhile managed an improvement of 0.7% in Q2 while consumer confidence actually rose in August.

This is the first rise in consumer confidence since February but appears to reflect a relief that a double-dip recession has been headed off to date at least as opposed to being due to the mild economic recovery. However, the gain in confidence only serves to reverse previous falls and with an increase in VAT not far away it wouldn't be appropriate to read too much into it.

Negative news in the UK has mainly focused around weakness in house prices which according to one set of data, from the Nationwide building society, have now had two months of declines. Thus house prices fell around 0.9% in August in comparison to a 0.5% fall in July and with modest rises preceding these falls house prices have essentially stagnated over the summer.

Other weak data included a slowdown in UK construction in August and weak UK manufacturing data. There is also the continual drip feed of news about Government cuts which can only serve to weaken sentiment. In our view the second half of 2010 was always going to see slower economic growth as the new Government focused on getting the country's fiscal position in order. This doesn't mean, however, that a double-dip recession in the UK will occur and we believe it remains unlikely.

The FTSE 100 broke below the 50 day moving average last week as it looked as though the near term rising wedge pattern had prevailed as the index has put in an intraday low of 5,070 on the 25th of August. However, since marking this low the index has broken back above the 50 day moving average to test the 200 day moving average resistance around the 5,340 level once more.

A break above the 200 day moving average on higher than average volume with a close 2% above this mark would revive the inverse head and shoulders pattern once more. The market continues to fake out the bulls and bears alike with frequent whipsaw moves in both directions on low volume. We would expect volume to pick up after Labour Day in the US which should finally result in a trend move that we can play with more certainty.

The Dow managed to penetrate through the key psychologically 10,000 level on August 27 to print an intraday low of 9,936.62. However it met strong buying interest at this region to finish back above the 10,000 level. The bearish moving average death cross in place since early July continues to indicate that short term momentum favours the downside, coupled with the short term downtrend in place bodes for a possible retest of the 10,000 level in the near term.

A convincing break of this level would likely lead to a retest of the July 21 low of 9,614. However, should this key level hold, a move back towards the 200 day moving average at 10,451 is also on the cards with the 50 day moving average at 10,260 a possible resistance point along the way.

Gold recently experienced a short term clean out, which saw the yellow metal find support at the 50 period moving average (green line) at US$1,210 on August 24. Since bouncing off this level, Gold managed to continue to appreciate to reach a recent high of US$1,247.25 on September 1.

Immediate resistance lies at the psychological US$1,250 level, which has lead to a period of consolidation. Once this pause is complete, a convincing break above US$1,250 would likely see a test of the June 21 high of US$1,265.