Gold...Is It a Dead Trade?
In theory, much has not changed with regards to the fundamental reasons to own gold as an investment. You still want gold to "protect" you from currency devaluing by the central banks in efforts to strengthen their individual economies (As central banks increase their asset purchases/ balance sheet, we expect more money in the system thereby fueling inflation and devaluing the currencies, this in turn makes domestic products cheaper to foreign companies and boosts an economy's exports). However, Something has clearly changed in the last few weeks for the price of precious metals to basically shrug off an increase in asset purchases by the US Central bank, an increasingly dovish Japanese government that threatens to debase their currency and continued reassurance of cheap money around the world... or has it?
Equity markets don't seem to think so, the Dow and other indices have rallied on the news and activities from central banks. Although other news seems to prop these indices up, I suspect that increasing the amount of liquidity in the global economy is the chief driver.
As it stands, it would seem that increased liquidity has caused a "risk on" mentality to run rampant in the markets. Whereas in the past, increased easing caused investors to be cautious of inflation, they have simply disregarded this notion today because they have seen no impact of inflation due to central banks easing. On one hand, it seems Ben Bernanke is achieving at least part of his goal when it comes to his monetary policy.
Bernanke has time and time again insisted that his aggressive monetary policy will achieve many things in order to strengthen the economy, one of them being the wealth effect (people feeling wealthier when their investments are doing well and in turn spending more money). As we have seen since the beginning of his policies, the stock markets have rallied by double digits and consumer confidence has increased, some would speculate about the causal relationship between the two, but regardless of ones stance on the matter it is impossible to deny that both have happened. So much so that the chatter now that of a consumer led recovery in the U.S. All this is good stuff, but what about the price of gold and why its taking it on the chin you ask?
Well there are a few possible explanations
1. The market is completely discounting the idea of inflation and therefore taking a risk on position in equities rather than a protecting their wealth with gold.
2. Glimmer of presumed brilliance with regards to solving the Euro Zone fiscal woes is causing investors to be more optimistic about the future, therefore increasing their risk appetite.
3. (And ill expand on this) The actual effects of the Fed's increased asset purchases are not being felt yet in the market until these purchases kick in in 2013.
Julia La Roche brilliantly notes that "The FED has committed to purchase $40Bn per month in MBS + $45Bn per month in Treasuries (QE). That’s a total of $1020Bn in QE next year, over $1 Trillion in balance sheet expansion. See right axis of chart below….That takes FEDs total assets from roughly $2.9 Trillion to over $3.9Trillion."
leaning on her analysis we note that this price correction in gold and precious will be short lived until we begin to see an expansion in the Fed's balance sheet.
Otherwise, the common theme in my analysis is that investors have an optimistic forecast for the future and expect to see a global resurgence in 2013.
Ultimately, it pays off to be well hedged; and having some exposure to precious metals is an excellent way to do so.
Till later Trade well
