Bullion in an Uncertain World

Excerpts from a speech to the 7th annual China Gold & Precious Metals Summit, Shanghai, China, December 5- 7.

Gold in recent months has been stuck in a trading range between $1,675 and $1,750 an ounce - disappointing many bullish investors and quite a few gold-market analysts (like myself) who had expected the yellow metal to be ending the year approaching – or even exceeding – its all-time high-water mark near $1,924 recorded back in September of 2011.

Recent attempts to rally higher have been thwarted by stepped-up speculative selling and softer physical demand with many buyers now conditioned to wait for the next dip.

At the bottom of this range, bargain hunting in the form of stepped up physical demand from central banks, sovereign wealth funds, and some of the gold-friendly hedge funds has created a floor under the market.

Changes in the aggregate gold holdings of exchange-traded funds (ETFs) have been a fairly consistent leading indicator of future gold prices over the past few years. Globally, gold ETFs purchased nearly 250 tons (about 800 million ounces) this year through November – and the total quantity of ETF gold held on behalf of investors now amounts to more than 2,600 tons.

It may well be that money flowing into gold exchange-traded funds is a consequence of the very accommodative monetary policies now being pursued by the Federal Reserve and many other major central banks across Europe and Asia – with rapid central-bank money growth a causative factor explaining both strong demand for ETF gold and the long-term upward trend in the metal’s price.

My own reading of the Federal Open Market Committee minutes from its last policy-setting meeting – along with statements and speeches by various Fed officials in the past few weeks – suggests there is a good chance the Fed will announce further expansionary monetary-policy measures in the next few months.

Predictions (from the OECD and other respected forecasting groups) of a worsening synchronized global economic slowdown – and a spreading sense of global gloom and doom – are contributing to the Fed’s sense of urgency, boosting the odds of further monetary accommodation sooner rather than later.

This fourth round of quantitative easing (or QE4) is likely to have more bang for the buck compared with QE3, which included among its measures the sale of short-term Treasury securities to fund its purchase of long-term Treasury notes and bonds.

With its inventory of short-term securities now mostly depleted, any future purchase of long-term securities must be funded with newly created bank reserves – which is, in essence, printing new money - some of which will find its way into gold and probably other asset markets.

Surprisingly, America’s fiscal crisis – and the much-discussed approaching fiscal cliff – have had little observable and immediate influence on the price of gold in recent weeks and months, if only because amid all the confusion, no one really knows how this crisis will sort itself out.

But, however it sorts itself out, we expect some combination of spending cuts and revenue hikes are in America’s economic future.

Unfortunately, a more restrictive US fiscal policy is exactly the wrong medicine for an ailing economy at this critical time, raising the odds of a recession or worsening recession-like conditions characterized by a palpable deterioration in employment/unemployment indicators for the US economy.

This bad news for the economy is – as bad news often is – good for gold.

Fiscal policies that promise slower business activity, falling after-tax household incomes, reduced household spending, slower recovery in the housing and construction sectors increase the likelihood of still-more stimulative Federal Reserve monetary policies.

America’s inability to get its fiscal house in order is compelling the Fed to pursue an aggressive monetary policy. But printing more money – indeed printing unprecedented quantities of money – will, sooner or later, result in a resumption of the US dollar’s long-term downtrend both at home and overseas . . . and, as night follows day, a substantial and unprecedented appreciation of the dollar-denominated gold price.

Indeed QE4 may be right around the corner . . . and QE5 could come by mid-to-late 2013 . . . as the Fed struggles to prop up a still-faltering economy. If the past is a reliable predictor, these efforts by the Fed (and similar policies by other major central banks) suggest much higher gold prices ahead.

Whatever monetary- and fiscal-policy choices are made by the old industrial nations – the United States, Europe, and Japan – these economies and most other industrialized and emerging economies together face at least a few more years of painfully slow growth – and, for some, outright recession.

It took years, if not decades, for the United States and most other major economies to get ourselves into this mess – by consuming more than we could afford, with money we didn’t have, accumulating debt we couldn’t possibly repay.

Debt can be a magic economic elixir – at least for a while. It allows consumers, investors, governments and, indeed, entire nations to borrow from the future . . . in order to accelerate consumer spending, investment, government services and entitlement programs, and even military spending – much of which has been purchased in recent years against the promise of repayment some day in the future . . . in some cases by our children and grandchildren.

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