Gold Sets For Rally As Bernanke Fed And ECB Rev Up The Printing Press

Despite the recent lows in precious metals prices, a notable shift towards "preemptive monetary easing" by the Federal Reserve and a rising possibility of Euro zone QE could push gold prices up and continue on with their rally. The author of this article expects gold to have a "killer comeback."

Agustino Fontevecchia
5/17/2012 @ 12:49PM
Forbes

Gold has been flirting with 5-month lows over the last couple of sessions, but could be close to finding a floor. Despite underwhelming physical demand and persistent U.S. dollar strength, a notable shift toward “preemptive monetary easing” by the Fed, coupled with the rising possibility of Eurozone QE could fuel a new leg up in what has been a decade-long rally for the yellow metal.

It hasn’t looked good for gold over the last couple of months. Bullion prices dropped more than 5% in April and have continued their decline in May. UBS’ Edel Tully noted physical demand remains “underwhelming,” and that despite a pickup in purchases from India, the world’s largest importer of the yellow metal, it remains poor (especially given “the rupee gold price is at the lower end of this year’s trading range so far”).

Gold has shown a persistent correlation with risk assets that has been frustrating investors. With the U.S. economy definitely slowing and the European sovereign debt crisis taking a substantial turn for the worse, one would expect safe haven flows to pick-up. But capital has moved into Treasuries, bunds, and the U.S. dollar.

As I reported here last week, gold could be setting up for a killer comeback. Some buying on the dips has emerged, as VTB Capital’s analysts noted, and technical indicators suggest bullion is oversold, as Dennis Gartman pointed out in Thursday’s letter. The major catalyst, though, will be monetary policy.

Markets appeared to have discarded the possibility of further monetary easing in the U.S. after a few months of above-trend jobs growth early in 2012, while the European Central Bank’s two-rounds of liquidity injections (LTROs) had gotten the job done in Europe, until they didn’t. Spain’s unilateral decision to miss its deficit targets this year kicked off a series of disappointing European headlines, culminating in Greece’s divisive electoral results.

Talk of Greece leaving the Eurozone went ballistic over the last couple of weeks, with major policymakers from core Eurozone countries, particularly Germany, acknowledging the possibility. As Greece failed to form a government, and the more extreme left-leaning Syriza party gaining traction among voters, markets worried. The beginnings of bank runs were exacerbated by the bailout of Bankia in Spain. Europe’s sovereign debt crisis came back once again, with a vengeance, once again.

With serious storm clouds forming, central banks around the world have begun revving the printing presses. On Wednesday, the latest Federal Reserve FOMC minutes revealed a notable shift toward “preemptive policy easing,” according to Nomura’s economic research team. QE3 is unlikely, unless a full blown crisis erupts in the EU, they note, but more favorable terms in swap agreements with the ECB (resulting in lower dollar funding costs for EU banks) is definitely a possibility.

At the same time, the prospect of further policy support in Europe has clearly risen. On Thursday, the IMF suggested the ECB “may need to pursue unconventional measures,” according to Trade the News, adding that the institution headed by Mario Draghi “has scope for more easing.”

Nomura’s analysts skipped the foreplay: “the likelihood of Eurozone QE has increased,” they explained. As banks’ situation becomes more precarious (shares in Spain’s largest bank, Banco Santander, have fallen in 7 of the last 8 trading days), another round of LTRO-liquidity is by no means off the table.

What does this mean for gold? The yellow metal generally rallies when central banks flood markets with liquidity (recall the effects of QE2 on bullion prices), as it is seen by many as a store of value that cannot be debased. More QE in the U.S. should push the dollar down too, removing another barrier for gold.

Many have expressed their bullish views on the yellow metal, despite the recent rout in prices. Beyond Goldman Sachs’ call a few weeks ago, billionaire hedge fund manager John Paulson, who’s been bullish the yellow metal for a while, reiterated his position on Wednesday. Speaking at the Ira Sohn conference, he suggested investors buy AngloGold Ashanti, putting a bet on the miners, noting it trades at a discount compared to peers like Goldcorp. David Einhorn, who spoke on Wednesday but didn’t mention gold, revealed a sizeable stake in Barrick Gold this week in form 13F.

Gold, and gold equities in particular, have underperformed this year. Just like in 2011, the yellow metal could rally as the situation in Europe deteriorates and central banks, from Bernanke to Draghi, decide to move markets with their very visible hand. If you think Europe is going down, it could be a good time to jump back into gold.

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