A Test of Strength for Gold

Diverse opinions test critical thinking and a healthy market. Last week, we saw gold gaining strength and the SPDR Gold Trust experienced its largest one-day out flows since August 2011. The recent Fed meeting has also revealed a growing dissension among some of its members.

By Frank Holmes
Tuesday February 26, 2013 10:31
Kitco

When investing in gold, I often say diverse opinions promote critical thinking and a healthy market. I believe elevated groups of buyers and sellers create a competitive tug-of-war in the bid and ask price of the precious metal.

Last week, we saw the gold bears growling louder and gaining strength, as the world’s largest gold-backed ETF, the SPDR Gold Trust, experienced its largest one-day outflows since August 2011. The Fear Trade fled the sector following the Federal Reserve’s meeting that revealed a growing dissension among some of its members over the central bank’s bond-buying program.

Despite the discord, the Fed is continuing its course to purchase $85 billion of bonds every month and keep interest rates near zero. Ben Bernanke’s plan bloating the balance sheet to more than $3 trillion has been keeping the Fear Trade coming back for more metal.

For good reason, too, as the correlation between the Fed’s balance sheet and the price of gold has historically been very high, at 0.93, according to Macquarie Research. The firm found that for every $300 billion expansion in the balance sheet of the U.S. government, there was a $100 an ounce increase in the price of gold. When you factor in the Fed’s current bond purchases totaling $85 billion per month for the next nine months, the central bank will be adding $765 billion in new assets. “Using the previous ratio, this would compute to a $255 an ounce increase in the gold price,” says Macquarie. By this measure alone, gold would rise approximately 16 percent over the next several months.

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