Later this afternoon the Federal Reserve’s FOMC are widely expected to announce the tapering of QE. This month’s meeting has long been eyed as the one where Bernanke will make such an announcement. With this in mind gold’s recent declines have been attributed to tapering expectations. Many analysts have stated that should QE be tapered then the gold bull market will almost certainly be over.
Here at The Real Asset Company we struggle to see this point of view. Not only has gold responded negatively to the latest round of QE but it is not solely driven by the decision of one committee and the US dollar.
As we explain below, there are five good reasons why the long-term gold price will disregard any announcement that is made later today.
1. Gold doesn’t care about QE3
Just over one year ago, on the 13th September 2012, Chairman Ben Bernanke announced that the Federal Reserve would be embarking on QE3.
QE3, designed to ‘aid the US recovery’ and a ‘substantial’ improvement in employment numbers, has seen a further $45bn of mortgage–backed bonds being snapped up every month.
Once this round of easing was announced gold analysts and mainstream commentators alike declared that gold would reach new highs. Instead, gold has since dropped by nearly 23%.
This suggests that gold has not been falling in recent months because of tapering expectations.
However it does suggest that those who have been avoiding gold in anticipation of the impact of tapering may decide to invest after realising that the metal does not rely on QE. It is not unreasonable, therefore to wonder if we may see a surge in gold investment following tapering.
2. This is only tapering, not unwinding
When reading about the death of gold, following the tapering announcement, one would think that ‘tapering’ is synonymous with ‘unwinding’.
Unfortunately, this is not the case. Tapering will still see an accommodative monetary policy; the money supply and base will continue to be increased by billions every month. To be clear, the Fed is not going to announce that it stopping buying Treasuries and plans to unload trillions of assets into the market. Given the way gold has been treated, one does wonder if this is a common misperception.
Academic research shows that the gold’s price rise is more affected by the US monetary base than even oil. Legendary investor Jim Sinclair spotted the relationship between the Fed’s money creation and the gold price over thirty years ago. Spotting in 1980 that the monetary base was flat lining, he sold his gold, precipitating the end of the gold bull market.
Below shows that he timed it just right. Previous gold bull-markets have ended when the gold to monetary base ratio reached 4.8. When Jim Rogers pulled out it was 5.1. However, for us we are nowhere close to reaching this point. At the time of writing the ratio is at its lowest level in the period studied at 0.4.
And what about money supply?
If you check out our gold price calculators you can see the true gold price based on M1, M2 and MZM. When valuing gold against money, the most common method is to value gold as if it were backing the world’s reserve currency, the US dollar. Use the sliders in our gold price calculators to see what the gold price per ounce could be today if the US dollar was backed by gold.
You can choose which measure of money supply to use, and how much you want to back the dollar with gold. You can chose to back the money supply by over 100 per cent, as in the dollar crisis and gold mania of 1980 when US bullion reserves were at one time worth over 1.5 times US money stocks.
Using these time-tested ways to value gold, it is clear to see that the yellow metal remains undervalued.
3. Do the Chinese and Indians care about QE?
For all the chatter surrounding QE and tapering, one would be forgiven for thinking that the US’s easy monetary programme is the underlying reason for buying gold.
Events of the last five months suggest otherwise. Since the gold price crashed in April, the movement of gold from West to East has been well documented. Few can deny the opportunity Eastern investors took to buy gold when the price fell so significantly.
The question of whether or not the FOMC will announce tapering tomorrow has been hotly contested since the first quarter of the year. However this has not been a major factor when Eastern investors have considered buying gold.
According to the World Gold Council (WGC) people in China and India have a “particular positivity around longer-term expectations for the gold price.” Not only this, but the expectations, held by these investors, for the gold price to rise increased between May and July.
Given the fall in the gold price below $1,300/oz overnight we see that this opinion shows a clear difference in the approach to viewing the gold price between speculators and those who want to hold the physical metal.
As we alluded to in a summer research report, the nature of gold demand is changing. Whilst the gold price in the short-term is determined by speculators and concerns over the decisions of central banks, there is a growing pressure on this paper system. In the end the long-term approach taken by those in the East will be the one that affects the gold price in the coming years as they remove the hard stuff from the system, leaving a more precarious paper version behind.
4. Gold’s biggest gains came without QE
The Federal Reserve’s first foray into official hyper-active money printing came in November 2008, followed by QE2 in 2010 and of course QE3 in 2013.
As we mentioned above, gold has barely responded to QE3 this year. Whilst one could argue that it has reacted to past attempts at inflating the economy, the annual climb in the gold price following QE announcements have not prompted the biggest climbs in the gold price.
This suggests, as we allude to above, that the US’s QE policy is not the only factor driving the gold price. QE was not predicted in the early 00s, yet the gold price continued to rise, why, therefore, does gold suddenly need QE to continue to do so?
It is also worth noting that during this period gold has continued to increase in the face of an apparently improving economy. Between 2001 and 2012, there was not only a housing boom and bust but also gains in the stock market until 2007 and the commodities peak of the same year.
The rises in the gold price, since 2001, were steady years of strong gains achieved without any QE. Whilst the panicky selling of gold – such as we see now – Seems to forget gold’s performance between 2001 and 2007.
5. Take a look around, it’s a currency war out there
Ben Bernanke said recently, ‘Nobody really understands gold prices and I don’t pretend to understand them either.’ Given the common belief that gold only reacts to US policies, this is an accurate statement.
Not only are there seasonal factors that will continue to support gold in the short-term, more importantly there are the monetary policy decisions of other central banks. The relationship between the gold price and the growth of central bank (UK, US, Japan and EU) balance sheets is highly correlated, by around 95%.
Whilst we argue above the gold price has not increased solely due to the US’s easy monetary policies, it cannot be denied that for every $1 trillion cumulatively accumulated on the UK, US, EU and Japan’s balance sheets, gold climbs by around $210/oz. Gold is acting as a currency barometer.
It is clear that the price has declined as the cumulative balance sheets of banks also declines, however Japan, the EU and the UK have also recently committed to further easy monetary policies. Once again, gold does not just need an irresponsible Fed in order to drive upwards.
As we have mentioned before, the price of gold in dollars matters very little if you do not earn or save in US dollars. Instead the actions of your central bank and the value of your money is what affects the gold you buy.
Irrespective of its price, and what it is priced in, gold held long-term has historically shown itself to be a hedge against currency-debasement. One cannot give-up on gold through short-term volatility and crises – to do so shows a misunderstanding of this most unusual of asset classes. The dollar, euro, yen and pound have been hugely devalued in the last decade. One announcement from the 12 committee members does not render this fact null and void.
As our own investors and readers have told us, tapering does not remove the reasons to hold gold, if anything it only increases them.
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