Gold Prices and Fed QE
Is the Federal Reserve's latest announcement fully reflected in Gold Prices...?
PETER HUG is director of global trading at Kitco. He has been involved in precious metals since 1974. Hard Assets Investor recently caught up with Hug to discuss the outlook for gold and silver after the Fed's big announcement...
HAI: The immediate reaction to the Federal Reserve's long-awaited third round of quantitative easing has been positive for gold, as one might expect. But is QE3 already priced in after the big rally from close to $1500 to nearly $1800?
Peter Hug: I don't think so, though the market may be a little tired at these levels. Back in early August, when gold was trading under $1600, we were looking for gold to rise to $1720 and for silver to rise to $33 or $34 after Labor Day.
There are many factors supporting gold and silver. First, the announcement by the European Central Bank that it would start its bond-buying program last week, the ratification by the German courts that the bond buying is constitutional for Germany, and finally, the latest Fed action.
It's not so much QE3; the Fed didn't add a specific amount of money. What they said that was more substantive than in past conversations is that they will continue to create liquidity for this market and continue to buy mortgage-backed securities even after the economy shows signs of recovery. Additionally, they extended their zero-interest-rate policy an additional year, to mid-2015.
The Fed has given the market a green light. You're going to get free money. If you're a little worried about the risks in the stock market after these runs and you're getting zero on your bond returns, you might look at the commodity sector to buy. Thus, gold and silver reacted accordingly.
HAI: Now that the Fed has played its cards, what do you see as the next major catalyst for gold?
Peter Hug: The Fed hasn't played its cards. It will continue to play its cards. I think that was the subtle, but major, difference in what Bernanke said. That said, you have issues in the European Union that have not yet been resolved. This is a very-headline-driven market. Europe is an issue that will continue until there's some clear evidence that the sovereign-debt crisis has been solved. I don't think we'll see that evidence until at least sometime probably spring or summer of next year.
Furthermore, the US election is coming up, and you have the fiscal cliff coming at the end of the year. Any of these uncertainties is going to create floors for precious metals. I'm not discounting the fact that gold may drop $80 from here or that silver may give back a Dollar or two. But I think these markets need to be purchased on pullbacks.
HAI: Speaking of that fiscal cliff you just touched on, how do you see that playing out for gold? That's a positive, I assume.
Peter Hug: It depends. It could be a positive, depending on how politicians address the fiscal cliff coming up. Congress is probably going to extend the tax credits or the tax breaks for six months to a year ahead of the election, which will give the incoming president the ability to deal with it.
The worrisome part about the fiscal cliff is that [ratings agency] Standard & Poor's has warned that if there isn't some concrete action taken, it may lower the US credit rating. The last time that happened, the US stock market took a major hit, which should be beneficial for the metals. But what happens when you have that type of a hit to the stock market is that everybody starts looking for liquidity. Metals tend to be very liquid. So you'll also get some selling pressure on the metals when that happens.
HAI: You said that the European Central Bank's bond-buying program set off this latest gold rally. How is that program different than the Fed's quantitative easing?
Peter Hug: The aims of the programs are different. They both expand the balance sheets of the central banks by printing money. In that sense, they are similar. But the Fed is not buying these mortgage-backed securities because they're worried about US yields. In Europe, the ECB is worried about yields —such as the Spanish yields, which were over 7 percent at one point—where it's almost impossible for the governments to borrow money and then be able to pay it back at those rates.
The ECB is not buying bonds to bump up employment. They're doing it to create liquidity for the banking system. The Fed and the ECB are injecting cash into the economies, liquidity into the economies, with different aims and motives.
The net result, however, is that both balance sheets of the ECB and the Fed are expanding, which means money is being printed. And there is then a perception that somewhere down the road there is going to be an inflationary price to pay for this. And that's why the metals are taking their cue from this expansion of the balance sheets right now.
HAI: We've seen a big reaction in platinum to the mine strikes in South Africa. Is there going to be any impact on gold production out of that country?
Peter Hug: Only a minor impact, because gold production is fairly widespread globally. South Africa accounts for 70 percent of the world's platinum production and just slightly under that for palladium. A severe strike in South Africa—specifically on the mines that are now on strike—has significant supply ramifications for platinum, palladium and rhodium. Whereas for gold, it'll have only a minor impact. Gold production globally can certainly meet demand without South Africa participating.
HAI: Let's move on to silver. The metal has had a great run-up to nearly $50 last year. But since then, it's fallen significantly, though it's rebounded with gold recently. Are you bullish on silver? And will it ever reach the $50 level again?
Peter Hug: "Ever" is a small word, but it has a large connotation. If we do it on a parameter of last year, gold hit a high of $1925 and silver hit a high of $50. If gold hit $1925 within a week—just to give you a time frame—silver probably would make it up to the $38-40 range. Should gold continue through $1925, silver seeing $50 is certainly within the realm of possibilities.
One factor against silver is its big industrial demand component. If the global economies are slowing down, that may weigh on demand for the metal. There is an argument for silver not running as quickly through these levels as gold. Silver has made a phenomenal move from the $26 range in percentage terms, relative to gold. Still, if gold gets up to $2000/oz., $50 silver is certainly realistic.
HAI: Speaking of those numbers, what are your price targets for gold and silver?
Peter Hug: If the Fed continues to be accommodative to the economy, and interest rates stay at zero through 2015, there is a realistic chance of seeing gold in the $2,200 to $2,400 range. If gold got to those levels, I can see silver in the $53 to $55 range.
On the down side, if the stock market collapsed and the Dow fell 2,000 points or 3,000 points over a period of two or three weeks, it's conceivable we'll see gold back down under $1600 and silver down between $29 and $31. However, I think we've seen the low for silver at $26 and we've seen the low for gold at $1,530.
Again, I'm a buyer on any sustained weakness in the metals because the Federal Reserve is going to keep printing money as long as necessary, which is very price positive for the metals.
HAI: Looking longer term, what is going to be the biggest driver of these metals? Is it the sovereign-debt fears? Monetary policy? Or is it currency movements?
Peter Hug: Monetary policy, though if it's not combined monetary policy between the Europeans and the Fed, there'll be currency implications as well. We've seen that with the US Dollar, which has dropped about 8 percent in the past four weeks. It was trading at 1.20 to the Euro and now it's approaching 1.30 to the Euro. As the Fed keeps interest rates at zero, stimulates the economy and puts more liquidity into the market, it makes Dollars more abundant and creates less demand for Dollars. That's why the Dollar has sold off.
The Dollar sell-off off has been price supportive for the metals. But going forward, monetary policy is going to be the primary driver for precious metals, with the caveat being that geopolitical risks are also going to come into the picture, especially in 2013. I think the Iran-Israeli situation is going to come to a head in 2013. And some of the problems that we're now seeing in the Middle East are only going to get worse, they're not going to get better.
So with those types of events, what I call flash-point events—where if something happened and oil shot up to $140—you could easily see the metals move up 5 to 20 percent on a fairly quick move. But on a sustained basis, monetary policy will drive the metals.
HAI: What do you see as causing the end of the bull market in gold and silver?
Peter Hug: The end will not come until the Federal Reserve starts to raise interest rates, which they say they won't consider until 2015.
As they raise interest rates, gold will have a competing asset in government debt—something that's safe and generates a return. But until interest rates get up to a 5 or 7 percent level—which is probably a minimum of three years away—I don't see risk to precious metals on the monetary policy side.
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