Many economic optimists have come to dismiss inflation as if there were some time limit on when it will occur. Inflation is a catch 22 of quantitative easing, the law of supply and demand dictates that oversupply keeps prices low but as demand increases so does cost. The same will occur in the US economy, we have an oversupply of money and as the economy recovers more dollars are put to use and thus the cost of those dollars increases.

Quantitative easing is proving to work for the time being as the Fed buys distressed assets from 2008, allowing financial institutions to lend again. This has resulted in the recent upsurge in M&A activity and the investment in equities.  Though quantitative easing may have stimulated confidence in the stock market there is little understanding as to what will happen when it stops. Quantitative easing will have to end as the debates over the deficit has taught us.

….A few participants noted that they already viewed the costs as likely outweighing the benefits and so would like to bring the program to a close relatively soon. A few others saw the risks as increasing fairly quickly with the size of the Federal Reserve’s balance sheet and judged that the pace of purchases would likely need to be reduced before long. (Attribution: Federal Reserve) http://www.nasdaq.com/article/weekly-review-will-markets-correct-when-quantitative-easing-ends-cm236290#ixzz2RJklwe1A

When quantitative easing does end,  it will be a bet on whether markets will be able to generate enough wealth (new money) in order to keep the $40B a month pace the fed has put forth. If this pace cannot be maintained then prices will increase and gold again will be the safe haven for investors.

Gold has slid .5 percent so far this year. The most recent causes for continued decline are the Cyprus bailout deal and recent US economic data. Though these events may indicate a change in the global economy’s direction the greater trend is easy monetary policy’s link to the price of gold.

The Troika (ECB, European Commission and IMF) willingness to compromise with Cyprus strengthened the Euro and thus devalued gold as a hedge. Across the Atlantic a recent Gallup pole indicates economic confidence after a post sequester slip. This sentiment is supported by the recent climb in oil to $96 a barrel.

The greater trend however continues to be the threat of inflation from easy monetary policy. $85 Billion dollars were injected into the US economy last month. You can see in the below chart the tie between the monetary base and gold.

- see chart -

gold vs money supply (version 1)

“The official reserves of global central banks have grown from $2 trillion in 2000 to more than $12 trillion in 2012. During this same twelve-year period, the data shows significant shifts away from the U.S. dollar, while the share of “other” currencies in reserve composition has tripled in absolute terms since 2008.”

Attribution: World Gold Council

Central Banks across the world continue to purchase gold including Mongolia, Kazakhstan, Azerbaijan and Ukraine adding to their gold reserves this month. With monetary policy continuing to build up pressure for inflation investors should continue to consider gold as an alternative investment to the slowly recovering world economy

Bernanke has outlined that the Fed will continue to implement quantitative easing for the foreseeable future. This has caused a hedge investment in gold in order compensate for the impending rapid inflation due to an oversupply of US dollars if the economy continues to improve. This however is not an immediate concern for the Chairman.

“We do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more rapid job creation,”

The second element affecting the American economy and thus gold is the Sequester. The Sequester started as a contingency for not breaching the debt ceiling in 2011 and includes $1.2 trillion worth of tax cuts over the next 10 years. It started Friday with an expected $85 Billion in spending cuts. While spending cuts are the correct steps toward lowering the deficit it will butcher the federal budget and immediately start laying of teachers, military employees and even slow the clean up for super storm Sandy. The only budgets that will not be affected are Medicare and Social Security. This is estimated to cut GDP growth by .5 percent.

Uncertainty always brings investment to gold and this is why it has continued to rally. Congress will be cutting $85 billion. This means gold will most likely rise and be poised for growth if in fact the economy dips again.

Shinzo Abe, the new prime minister of Japan, has made some big promises. The most notable of which is his plan to throttle the autonomy of the Bank of Japan by ousting governor Masaaki Shirakawa. It is likely that Mr. Abe will appoint someone with a more Bernakesque style of monetary policy.

Though Mr. Shirakawa is still governor Bernakesque style quantitative easing for Japan has begun. The country has already issued extensive bonds over the past decade in order to shore up the Yen and on Tuesday January 22nd the Bank of Japan issued a statement saying it will purchase 13 trillion yen ($146 billion dollars) per month to raise inflation to a target of two percent. This is significantly more then the QE3 in the US, which is pegged at $40 billion a month.

“This is definitely bullish for gold,” James Cordier, the founder of Optionsellers.com in Tampa, Florida, said in a telephone interview with Bloomberg news.

Gold shot up on Tuesday with Bank of Japan news to 1,685.90. It should be expected that Gold continue to increase as Japan continues its quantitative easing into the future. As long as currencies continue to fluctuate erratically investors will hedge in safe havens like gold.

China’s gold demand is expected to grow 1 percent this year to a record of around 860 tonnes. Their ministry of industry promised: ‘In order to strengthen the gold industry the government will increase gold mine investment, speed up industry consolidation and international cooperation. It also said it would ‘develop gold trading platforms and investment variety (presumably meaning ETFs). According to MIIT this strategy could lead to China doubling their gold demand by 2015.

China will overtake India in overall demand terms and as the world’s largest jewellery market. The global head of metals at consultancy Thomson Reuters GFMS said China’s jewellery demand is expected to climb to around 520 tonnes from 515 tonnes in 2011.

“Physical demand is very strong,” said a Beijing-based trader. “It’s a combination of the attraction of lower prices as well as pre-holiday demand.” (The Lunar New Year is February 10th)

China’s jewelry sales jumped by 19.3 percent in the first eight months from a year earlier, Shi said, citing the National Statistics Bureau. The government doesn’t give a breakdown on jewelry sales.

Gold as a means of investment for China is seen at around 270 tonnes, up from 265 tonnes last year. China is looking to diversify its assets away from the US dollar and to protect its national savings against devaluation and inflation by investing in one currency that no central bank can print. Ironically the nation faces quite a challenge in achieving this because it cannot raise gold output anything like as fast as it would like.

The balance, of around 70 tonnes, is industrial consumption.

The combination of the scarcity of gold and China increase in demand will keep prices heading higher for the foreseeable future.

Sources:
Business Insider
Arabian Money

In addition, Europe Union may have finally bottomed out but there is still great uncertainty at what pace the European Union will recover.

“Foreign investors are gradually coming back and Spain can live with the current yield levels,” said Tobias Blattner, an economist at Daiwa Capital Markets in London, referring to a 10-month low in Spanish borrowing costs. This being said the Spanish Economy Minister Luis d Guindos said job creation won’t even start until the end of 2013.

Canada continues to be one of the strongest economies in the world with both the IMF and OECD saying it will be the fastest growing country in the G7 next year.

“We think gold still has a chance of breaking above $1,800 and even reach $1,900 in the first half of the year due to fragile economic recovery in the United States and easing policies by central banks,” said Li Ning, an analyst at Shanghai CIFCO Futures.

“Gold gained 0.6 percent to $1,658.60 on Monday. But prices may weaken in the second half if the global economy gets on a steady path to recovery and stimulus measures taper off”, she added.

For now there are too many conflicting reports to say with any certainty the world economy will see sufficient growth in 2013. You couple this with the still strong physical buying of gold in India, China and Southeast Asia along with hedge fund and money managers makes 2013 bullish at least for gold.

The primary hurdles facing the ECB are agreeing on interest rate cuts to control inflation and raising the money to cover Spain, Greece, Italy and the other crippled economies in Europe. Italy is currently the center of focus as Prime Minister Mario Monti prepares to resign. Italy is a keystone in the European economic crisis so the transition is being watched closely. This pressure has prompted a calm and measured statement from the Prime Minister.

I understand market reactions, they need not be over dramatized. Let me also remind you that the current government has not left and is fully in charge and will be so until a new government comes up after parliamentary elections.

Monti’s monetary policy has been held in high regard though as austerity measures continue so will the lowering of the key ECB rate. This lowered rate will hurt the Euro because it reduces the allure of Euro-denominated assets as the interest-rate premium over the Federal Reserve’s key policy rate, currently between zero and 0.25%, shrinks.
Meanwhile the unknown future tax policy of the the United States continues to spook investors.

The loss of all of this open interest signals the institutions are moving to the sidelines until after an announcement on the ‘fiscal cliff’

said George Gero, vice president of RBC Capital Markets, referring to talks aimed at resolving a potential U.S. budget crisis at the year-end.

Its seems the sidelines will involve gold. Gold is traded in American dollars so as the US economy continues to recover faster than the EU the precious metal will continue to be a hedge for European Investors and Banks.

The re-election of Barrack Obama last Wednesday means a lot for American fiscal policy, taxes and thus gold. Monetary easing can be expected to continue, the Bush tax cuts will likely be adapted and gold will see an increase as investors protect themselves from further uncertainty.

With President Obama comes further money printing to subsidize the toxic mortgage backed securities still circulating from 2008. If Bernake’s fiscal policy in 2012 is any indication we will see another several billion dollars injected into the US out of thin air in early 2013. This will again mean another bump for gold as investors continue to unload the weakening dollar. Furthermore, it is doubtful that the Euro and Yuan will have any greater appeal than the dollar in 2013 than they have now.

The real focus, however, is on the infamous “fiscal cliff” that now dominates the political discussion in the United States. Will the Bush tax cuts and Obama payroll tax cuts be allowed to expire, contracting GDP by .5% or will Republicans and Democrats be able to work together for the first time since the Clinton administration? No one wants another recession and both sides of the aisle offered a conciliatory tone last week but Obama is holding firm to his tax hikes on the top 1% of earners and Republicans still dominate the House of Representatives. This will hopefully result in a compromise and not a shut down.

“Marginal income taxes go from 35 to 40 (percent), capital gains from 15 to 20, dividends from 15 to who knows what…so they could go high, high and higher.” Said Pimco’s Bill Gross.

The item to watch here is uncertainty because that fosters investment in gold and why we’ve seen an increase in gold’s value over the last couple of days. However there is some guidance, it is doubtful that dividend tax will go higher than the pre-Bush rate of 40% according to a recent report by Ernst & Young. The Republicans still control the House of Representatives so 40% will be the ceiling with accommodations likely to be made under 25% of dividends if the trend of an average increase of 18% from the other taxes is followed.

With the Fed continuing to print money and investment dollars throttled by increased taxes investors will be looking for high performance stocks and the yellow metal to hedge. First Americas Gold combines the best of both worlds, a clean company poised for growth in one of the safest commodities on the market.

Quantitative easing is leading to inflation as the money supply outpaces the amount of goods and services within the world economy. Leaders in the ECB, CCB and the Fed have all made it clear that they are willing to accept higher inflation in order to sustain the fragile economic recovery we are currently going through. Our current inflationary trajectory means three things for gold.

First, a weaker currency is good for countries in the current economic environment. As global trade slows, a weaker currency becomes all the more important to maintain export competitiveness. The currency wars have provided a small cushion as countries have been able to flood the market with their respective currencies to compensate for the slowing exchange of goods. Since gold is not tied to currency it’s value will continue to increase as it takes more devalued dollars to purchase.

Second, low interest rates greatly impacts savers and investors. Since interest rates are being held artificially low savings held in currency will eventually lose money once inflation occurs.The almost universally negative real savings rates in developed countries are likely to see a shift of saving to real assets that will provide long-term real security.

Lastly, it is historically proven that inflation increases the gold price. Increase in money supply will be a potential catalyst for higher inflation in the future leading to higher gold prices. According to the World Gold Council a 1% change in money supply, six months prior, in the US, Europe, India and Turkey tends to increase the price of gold by 0.9%, 0.5%, 0.7% and 0.05%, respectively.

The combination of gold holding “real” value, artificially suppressed interests rates devaluing cash savings, and the historically proven increase in gold value during inflationary periods all indicate an inherent value in gold, its producers and its explorers.

Source: http://www.gold.org/investment/research/regular_reports/investment_statistics_commentary/

The end of 2012 is the quarter of indecision. The two largest economic powers, the United States and China, are determining new leadership. Needless to say until new leaders are chosen investors are wary to move money. The current US fiscal policy of ease-until-its-fixed will continue for at least another 2-years under Bernanke, meanwhile China is already making changes.

China’s economic growth has slowed from 8% to 7.8% a year ago largely due to the fiscal mess in Europe eroding its exports.  China’s new leadership has said it will be focusing on internal consumption growth with further infrastructure, medical and educational investment. Even with the relatively mild quantitative easing last week the Yuan is remaining high. Unlike the rest of the world China can afford a more expensive currency and needs it in order to purchase commodities sold in American dollars.

As China plans to invest billions in infrastructure through state owned companies many of them will require metals and in order to compensate for its Quantitative Easing China will need to purchase gold. This combined with the continued fear of a global recession will continue to keep gold on an upward trajectory.

In short buy gold stocks and sell bonds.

Source: http://www.businessweek.com/news/2012-10-07/dim-sum-yields-fall-as-offshore-yuan-strengthens-china-credit