by Louis Golino for CoinWeek ……
On Thursday, September 13, 2012 at the conclusion of a two-day meeting of the Federal Open Market Committee, Federal Reserve Chairman Ben Bernanke announced a third major round of quantitative easing, or QE3.
This follows last year’s Operation Twist program in which short-term bonds were sold and used to buy long-term bonds to the tune of $45 billion a month.
The Fed decided at its meeting, in an 11-1 vote, to launch an open-ended program in which they will purchase $40 billion a month of MBS, or mortgage-backed securities, until the labor market improves. They also provided what is known as forward guidance on interest rates, stating that rates will be kept low even for some time after the economy improves.
Many analysts see the Fed move as akin to “QE now, QE tomorrow, QE forever,” but in reality the program is conditioned on the performance of the economy and labor market. After two months, the Fed will assess the situation and see if further purchases are warranted and in what size. In practice, that is expected to mean a long period of purchases since the labor market is not likely to improve substantially for an extended period.
But at some point the U.S. economy will pick up considerable steam, as will inflationary pressures, and the Fed will have to pull back its QE programs.
The Fed also wanted to do what it can to try to stimulate the economy before we go off the legally-mandated fiscal cliff at the end of the year. But during his press conference, Bernanke said the Fed really does not have the tools to address the fiscal cliff.
All of this comes right on the heels of a major bond buying program by the European Central Bank to shore up the euro, and a qualified endorsement of Germany’s participation in the European Union’s bailout program for troubled countries like Spain. Already the ECB actions have brought lending costs and bond yields down substantially in the European countries having the most problems.
These developments matter for precious metal investors because the Fed and ECB actions both help support higher prices for precious metals. The ECB action is designed to, and is having the effect of, making the euro stronger, while Fed action will likely further depress the dollar’s value. Both of those developments will support metal prices.
Just before the announcement, precious metal prices briefly dipped, as they usually do before a major increase, in this case because of a widespread view that the Fed would end up disappointing the markets by only providing interest rate guidance or launching a smaller and more limited easing program.
The Fed ending up doing much more than most people expected, and precious metals rose sharply in reaction. Gold immediately shot up at least 2% to a six-month high, reaching as much as $1775 during the day of the Fed announcement and again that evening, and silver rocketed up 5%, getting very close to $35.
So what are the implications for precious metals of these major developments on the monetary policy front?
First, the typical reaction is that we are “off to the races” with precious metals. To a large extent, that is likely to be the case, especially for the next six months or so. But prices won’t go up in a straight line. There will be pullbacks, dips, profit taking, and all the rest along the way.
In the short-term many experts expect gold to consolidate around the $1800 level before going to the next level. For example, UBS analyst Edel Tully told Kitco (www.kitco.com) that “Now QE3 is actually confirmed……gold’s upside pace should slow down. A consolidation would not be a bad thing for the metal.”
If QE3, and the potential for higher inflation, were the only factors supporting higher metal prices, I would be concerned about what happens when the economy eventually gets back to something resembling normal, and the Fed “punch bowl” of QE is removed. That does not mean all the jobs lost in the recession will come back. A lot of them will never come back because of structural change and globalization, but the economy should eventually get substantially better.
If our political leaders also get their acts together, and develop credible ways to deal with current and longer-term problems, which is something most analysts view as unlikely no matter how severe the consequences of going off the fiscal cliff, there is a real chance metal prices could someday correct substantially. But we are a long ways off from that, if it ever happens.
QE3 is in many respects a signal to investors that they are better off investing in riskier assets like precious metals and stocks because they will earn a negative real rate of return on money saved in banks or used to buy Treasury bonds.
Higher metal prices will also be supported by a wide range of other factors as well such as rising geopolitical tensions over the Iran nuclear issue and unrest throughout the Middle East in the aftermath of the protests sparked by a crude anti-Muslim film.
There are also factors that are specific to each metal.
Silver could be heading towards a major supply crunch. It is still readily available at the moment, but supply bottlenecks may be coming soon. A lot of analysts see silver reaching its 2011-high of almost $50 in the near future. Silver will probably outperform, but volatility will remain very high.
Platinum and palladium have outperformed other precious metals recently, and are likely to continue doing so. Both are used widely in the automotive industry, which is doing surprisingly well despite the global economic slowdown.
Labor unrest at mines in South Africa is expected to continue to support higher platinum prices for months, but platinum could also decline sharply if the economy were to go back into recession or worse, which could happen because of the fiscal cliff.
Gold should continue to do very well in the coming months. Most experts expect the price of gold to reach or exceed its previous nominal high of $1900 from August 2011 later this year. That is probably where the metal could meet some short-term resistance. There are also widespread predictions that gold will go well over $2,000, which is certainly possible.
Prices will consolidate at higher levels, and will be underpinned by global currency debasement. But to truly go parabolic, some additional major catalysts will probably be needed such as an acute international crisis, global financial crisis, or at least sharply higher oil prices. And if the plan to save the euro falls apart, and once again puts pressure on European borrowing costs, investors should expect to see metals come under pressure.
Louis Golino is a coin collector and numismatic writer, whose articles on coins have appeared in Coin World, Numismatic News, and a number of different coin web sites. His column for CoinWeek, “The Coin Analyst,” covers U.S. and world coins and precious metals. He collects U.S. and European coins and is a member of the ANA, PCGS, NGC, and CAC. He has also worked for the U.S. Library of Congress and has been a syndicated columnist and news analyst on international affairs for a wide variety of newspapers and web sites.