FED EASING AND GOLD PROSPECTS
This week’s news from the U.S. Federal Reserve promising massive quantitative easing in the months ahead greatly increases our confidence in the long-term bullish outlook for gold and silver. Since the first recorded use of currency by King Croesus some 2,500 years ago, there has NEVER been a rapid increase in the supply of money that has not, within a few years, been followed by an acceleration of inflation. Why should the current experience be any different!!
Our forecast that gold will reach a cyclical high over $2500 and silver will exceed $50 an ounce in the next few years looks increasingly more likely with each step taken by the U.S. central bank and other economic policymakers to jump-start the economy.
Where Next for Gold
Does this mean that gold will suddenly be moving to new historic highs?
Gold prices had been softening in recent days, dropping as low as $883 in world markets and looked vulnerable to further price erosion just before the Fed announcement. Then, a rush of buying and much short covering in a thin market took the price quickly up to $954 before it settled back a bit. In next day trading, gold seems to have defined a $950 to $960 trading range — but it wouldn’t surprise me to see it slip $10 or $15 lower in the days ahead.
Importantly, the latest price action now leaves gold in a much stronger technical position with well-fortified support under the market in the $880 to $900 range. There’s a good chance we will never again see gold below these levels.
What of the upside? Longer term — as I have been writing in these pages for over a year — we are going to see gold more than double and silver more than triple.
However, short term, for the months immediately ahead, there are important limiting forces that could hold gold back unless or until investors are once again willing to step up and take a hundred tons or more a month in physical metal.
Importantly, the market for gold is global and fairly democratic, not limited to the wealthy or elite — and powerful forces in other countries and regions can be just as significant determinants of the yellow metal’s price as developments here in the United States.
Let’s not forget what stopped the gold train in February when it very briefly ran through $1000 an ounce: Gold was humbled by the flow of scrap supply as holders of old jewelry cashed in at what they perceived to be very attractive prices for their old bangles, bracelets, chains and other gold items. This is what my old friend and gold historian Tim Green called the “mood of the souks.”
For example, the importation of gold into India, historically the world’s biggest buyer of gold, has been close to nil so far in the first quarter. Not only has buying dried up . . . but individuals — from all walks of life — selling back to the market has boomed. Gold prices denominated in Indian rupees were at historic record highs earlier this year and remain very attractive to Indian sellers. A similar story can be told about Turkish and Middle Eastern gold-market activity — both important centers of the world gold trade. Compounding the negative effect of high prices on fresh demand, the collapse in consumer spending everywhere has knocked down world jewelry fabrication demand to the lowest levels in decades.
Should investors push gold prices back up too far, too quickly, an increase of scrap from the four corners of the world will likely limit and reverse the advance. But if gold remains near current levels or rises slowly in fits and starts, scrap flows should diminish as the most price-sensitive material is depleted and sellers gradually adjust to higher price levels . . . and this will set the stage for a more sustainable advance and another leg up in the longer-term gold price cycle.
Long-Term Process
Over time, the most price-sensitive old jewelry in the weakest hands will be depleted, clearing the way for gold to move into a higher range that again will be capped by recycling of old scrap but at an incrementally higher level . . . and prospective sellers will also gradually become accustomed to higher prices and will demand incrementally higher prices for their old scrap.
I see prices over time moving higher in a step-wise fashion from one trading range to another as holders of old scrap at first limit each advance with scrap sales, then as their metal is depleted and they adjust to higher prices the market can again move up to a higher range.
Also, at times on the way up, investor demand will be powerful enough to overwhelm and absorb larger reflows of old scrap. This will occur, in part, because, for a time, a rising price itself is a very strong trigger for more investor demand . . . and because new gold investment vehicles and a maturing distribution system — especially gold ETFs — make it so much easier for so many investors and potential investors around the world to participate.
What the Fed Said
Yesterday, Wednesday, March 18th is a day that will go down in monetary history. The Fed announced an unprecedented program of monetary stimulation and credit creation. This “quantitative easing” in the jargon of economists promises an injection of another $1 trillion into the financial system through central bank purchases of both long-term Treasury bonds and mortgage securities. This is almost double all of last year’s quantitative measures undertaken by the Federal Reserve.
The Fed said it would buy an additional $750 billion in government-guaranteed long-term mortgage backed securities on top of the $500 billion in purchases announced last year plus another $300 billion in longer-term Treasury bonds over the next six months. The Fed also said it might expand its program to finance lending to consumers and businesses.
Since September, the Federal Reserve has doubled the size of its balance sheet to about $1.8 trillion. The actions announced this week are likely to expand its balance sheet to more than $3 trillion over the next few months.
Federal Reserve Board Chairman Ben Bernanke and his fellow monetary musketeers at the central bank are hoping this electroshock therapy will stimulate economic activity by lowering long-term interest rates including rates on home mortgages, apparently fearing the possibility of a second Great Depression more than the risks of higher inflation a few years in the future. The Fed is essentially printing money to raise the supply of credit and lower long-term interest rates — and praying that this will get the sick economy up and moving again. One thing is for sure, though: Printing money at the promised pace guarantees a return to high inflation and a much higher gold price in years to come.
Footnote: China’s Hidden Role in U.S. Monetary Policy
What’s not been much discussed in all of this is China’s influence on U.S. interest rates. In recent years, China has been America’s biggest financier, helping keep our interest rates low and America’s private and government spending high on easy credit. It’s growing trade surplus with the United States left it with billions of dollars that could only be invested in U.S. government debt. But with a diminishing surplus — and also lately spending more to stockpile raw materials — China’s financing of U.S. debt has slowed, threatening to push up U.S. long-term interest rates. It’s likely that the Fed’s latest actions are also intended to counter any upward pressure on interest rates associated with the diminishing Chinese surplus.
