July 24, 2024

Federal Reserve May Cause Stampede Into Gold and Silver This Week

At the end of a two day Federal Reserve policy meeting, Fed Chairman Bernanke has scheduled a news conference on Wednesday that has the potential to rattle markets worldwide.   Every analyst and investor at the news conference is certain to focus their questions on Fed plans after the scheduled completion of QE2  in June.

Current market expectations are that the Fed will not announce a new program of asset purchases and will initiate steps to slowly reduce the size of its bloated $2.5 trillion balance sheet.  Through the end of June, the Fed will have purchased $600 billion of treasury debt using newly created dollars, after having purchased $1.7 trillion of assets under QE1.

The Federal Reserve has been supporting the skyrocketing federal deficit by purchasing 85% of all new treasury debt since QE2 was initiated.   Some analysts think that interest rates on US debt will increase once the largest buyer of treasury debt steps aside.  The withdrawal of massive stimulus by the Fed could also cause a sell off in stocks and bonds, and result in lower housing prices and higher unemployment.  Under this scenario, another round of quantitative easing by the Fed would become inevitable.

Chairman Bernanke’s comments on the Federal Reserve’s exit strategy from a super easy monetary policy could cause major moves in many markets, especially precious metals.  If the markets sense that the Fed may need to initiate another round of quantitative easing, gold and silver prices will explode to the upside.  This prediction is based on the results of the current QE2 program which benefited certain asset categories but did little to help the average American.

Since last August when it became clear that the Fed would initiate QE2, we have witnessed the following results.

  • Home prices have continued to decline.
  • The 30 year mortgage rate has increased from 4.2% to 4.8%.
  • New housing starts declined to all time lows.
  • The 10 year treasury note rate has increased from 2.6% to 3.4%.

The Fed has continued its policy of near zero short term interest rates at the expense of consumers who receive virtually no return on savings.  Banks, meanwhile have increased US treasury and agency securities to a massive $1.7 trillion, benefiting from the spread between short and long rates.

The Fed’s policy of overt currency debasement, while helping to increase exports and earnings for multinational corporations has resulted in the dollar declining to the all time lows reached in early 2008.   Foreign countries with dollar reserves are protecting themselves by diversifying out of dollars and into other currencies and hard assets.

The lower value of the US dollar, while helping multinational corporations, has resulted in higher oil and food costs which has put  additional strains on consumers already burdened with excessive levels of debt and declining incomes.

Unemployment has remained stubbornly high despite unprecedented fiscal and monetary stimulus.  The Fed can print money but it cannot directly create an increase in real incomes for the average American family.  Nor can the Fed fool the people – recent Gallup polls show that almost half of the public has little faith in the Federal Reserve’s ability to do the right thing.

The Fed’s explicit policies of dollar debasement and zero interest rates risks triggering a major collapse in the value of the dollar.   Since last summer the dollar has seen a decline of 16% as investors do the logical thing and dump dollars.

Huge US  budget deficits, uncontrolled spending  and money printing by the Fed resulted in a warning by S&P that a credit downgrade on US debt was possible, putting further pressure on the US dollar.

QE2 liquidity did result in higher stock and precious metal prices benefiting a minority of Americans while doing nothing to solve the problem of too much debt and too little income.  Reliance on the Fed to come to the rescue with ever increasing amounts of cheap money has become the last resort, self defeating option.

The gold and silver markets are reflecting the failure of  unsustainable fiscal and monetary policies which virtually guarantee further appreciation in the precious metals sector.  Any pullback in prices should be viewed as a long term buying opportunity.

Gold Price Hits All Time High, Silver at 31 Year High

The Week in Precious Metals

Gold and silver continued their winning ways this week. Measured by the closing London PM Fix prices, gold gained $24.50 or 1.75%, while silver rose $1.89 or 5.81%. On an intraday basis, the gold price hit an all time high of $1,440.31 while silver traded to a new 31 year high at $35.55.

Gold’s advance for the week came after solid gains of $19 per ounce in the previous week.  Concerns about a weak dollar, skyrocketing oil prices and continuing turmoil in oil producing nations in the Middle East all contributed to reinforce the importance of gold for wealth diversification and as a hedge against a range of adverse economic conditions.

The ongoing surge in oil prices does not reflect an actual shortage in crude production.  Inventories remain robust and excess producing capacity seem adequate to replace all of Libya’s roughly 2 million barrels a year of production.  Rising oil prices reflect the fear that social unrest will spread to Saudi Arabia, the King of oil producers.

Saudi Arabia is surrounded by countries that are in massive social, religious and economic upheaval.   The contagion of violence and revolution has spread throughout the area included Algeria, Libya, Tunisia, Iran, Yemen and Bahrain.  If Saudi Arabia follows the path of its neighbors, the price of oil would quickly be on its way to $200 a barrel.  Small protests in the Saudi Kingdom this week may be a prelude to much larger upheaval in the months ahead.

Oil - Stockcharts.com

The money printing and inflation creation campaigns of the Federal Reserve seem to be giving the struggling U.S. economy some traction and there have been discussions by Fed members regarding the termination of quantitative easing after the current $600 billion round of money printing ends in June of this year.  However, much higher oil prices would quickly put the U.S. economy back into recession since consumer disposable incomes would be drastically reduced.

The Fed’s only easing option to fight another recession is to institute another round of money printing, which at some point leads to an inflationary spiral.  In Senate testimony this week, Fed Chief Bernanke admitted that “sustained rises in the prices of oil or other commodities would represent a threat both to economic  growth and to overall price stability.”  It is no surprise that gold is looking like a sensible option to more and more investors.

Precious Metals Prices
Fri PM Fix Since Last Recap
Gold $1,427.00 +24.50 (+1.75%)
Silver $34.43 +1.89 (+5.81%)
Platinum $1,828.00 +37.00 (+2.07%)
Palladium $811.00 +26.00 (+3.31%

Platinum regained some of its luster with a gain of $37 after last week’s loss of $45, while palladium was up $26 following last week’s loss of $62.

After a gain of almost 2% last week, silver continued its sharp upward price movement and gained $1.89 or almost 6% on the week.  On a percentage basis, silver’s gain on the week was almost three times the gain seen by gold.  Since last summer, silver has vastly outperformed gold, a trend that may continue.

If the gold to silver ratio returns to its long term historical trend of 16, the price of silver would approach $100 per ounce at the current price of gold.

The price of the ProShares Ultra Silver (AGQ)  jumped $23 points on the week to close at $204.19 while the popular iShares Silver Trust (SLV) jumped $2 dollars or 6.2%, closely tracking the price of the metal.

AGQ - Yahoo Finance