GOLD PRICE NEWS - The gold price dropped $9 to $1,113 this morning as the price of gold fell amid weakness in the euro, which declined 0.6% to 1.3543 against the U.S. dollar. With this morning’s gold price descent and yesterday’s nearly 1% decline, the price of gold turned negative by $4 for the month of March but remained higher by 1.6%, or $17 in 2010. The gold price selloff was also a reaction to yesterday’s Federal Reserve announcement on liquidity-draining measures which a susceptible market parsed as bearish for the price of gold.

The announcement by the New York Federal Reserve pertained to the expansion in the number of counterparties with which the Fed would transact reverse-repurchase agreements from the current 18 major banks that underwrite Treasury auctions to other financial institutions, including large money market funds. Last month, Fed Chairman Ben Bernanke outlined in testimony before Congress that the Fed may use reverse-repos when the time comes to quickly drain large amounts of liquidity from the financial system. Expanding the number of counterparties would make liquidity removal faster and more effective.

While the announcement stated that the expansion “is a matter of prudent advance planning, and no inference should be drawn about the timing of any prospective monetary policy operation,” traders drew inferences anyway, the major one being that Fed tightening action draws closer as the economic outlook improves. In a market that appears to react only to the latest headlines, the gold price fell on news of positive expectations for the Greek debt crisis and another major deal for AIG.

Although some measures of economic health - such as housing and the jobs market - have yet to find firm footing, GDP is moving in the right direction and corporate profits are strengthening. With the second AIG blockbuster asset sale in as many weeks, capital investment is on the move again. While the Fed is statutorily charged with conducting monetary policy in a fashion that promotes price stability, there is tremendous political pressure on the institution to achieve low unemployment through policies that bolster economic growth.

Hence, the Fed is tasked with performing a delicate balancing act that leaves little room for error: delay too long or act too tepidly in draining the financial system of the excess liquidity used to save it, and inflation will boil over; move too aggressively, and the economy will relapse. Unfortunately, policy administration cannot be measured at the margin and adjusted on the fly. Only after some time has passed can it be evaluated, and even then it is impossible to isolate and measure the effects solely attributable to it. It may be months before policymakers determine that the wrong path has been followed.

The predicament was underscored last month in a BCA Research Commodity & Energy Strategy Bulletin. While warning of risks ahead for gold stocks as central banks weigh when to normalize monetary policy, the Bulletin noted that “the unprecedented nature of the earlier financial and economic meltdown suggests that liquidity withdrawal will, at best, take place in fits and starts.”

But politics will eventually trump policy. The political imperative to drive down joblessness will likely keep the system awash in liquidity until a number of percentage points are cleft from the unemployment rate, a time frame that may span years rather than months if the consensus outlook is to be believed. The picture not only favors the long-term outlook for the gold price, but should confine the short-term downside exposure that lies ahead.