The US Federal Reserve has given you another two big reasons to hold gold.
First the Fed announced it would keep US interest rates close to zero for at least the next three years.
Anything can change, but it looks like the Fed, and other major central banks, are committed to keeping interest rates low for a long time. They’re willing to risk higher inflation in order to make debt refinancing more affordable.
The longer interest rates stay low, the better it should be for gold. When a bank doesn’t pay interest, then it doesn’t matter that gold doesn’t pay interest either. So there is no ‘opportunity cost’ in holding gold.
Second, the Fed has suggested twice in recent weeks that more quantitative easing is in store.
In his testimony to the Senate Budget Committee, Federal Reserve Chairman Ben Bernanke told the Senate not to be fooled by the falling unemployment figure – the labour market was in bad shape and suggested more quantitative easing (QE) could be on the cards. The first round of QE saw the US gold price rise by 70%, and the second round by 20%.
On the back of QE, the debt securities held on the Fed’s balance sheet have already more than tripled to over $3 trillion in a few years. But the Fed is not alone. The European Central Bank’s balance sheet has also tripled in a few years and now holds close to 3 trillion euros of debt. The People’s Bank of China’s balance sheet is no better, and has more than doubled since the crisis.
The major central banks of the world are trying to stimulate growth by weakening their currencies quicker than each other. They are locked in a game of chicken where no one wins in the end. As the Fed, ECB and People’s Bank of China race to print more money than each other, the price of ‘real things’, such as commodities, rise.
Nowhere is this felt more than in precious metals. They benefit from having some status as currency. Gold is simply resuming its 5000-year old role as the only money that can withstand the actions of central banks.
The clock is always ticking for gold explorers.
Their goal is to find enough gold to keep their share price rising. That way when they’ve burnt through their cash they can raise more from the market. And it’s never cheap to drill thousands of holes in isolated and remote parts of the world.
Having strong gold price forecasts makes it easier to raise money for explorers. But more importantly explorers thrive when there is some appetite for risk in the market. It keeps prices up, so helps raise more money to expand the scale, duration – and therefore potential success rate – of their exploration programs.
And there is suddenly much more risk appetite now than there was last year. Junior gold stocks have turned up sharply in the last month.
There are a few reasons for this.
The big turning point was in mid-December when the European Central Bank (ECB) started its own version of QE. The ECB has lent European banks half a trillion three-year, 1% loans via the Long Term Refinancing Option (LTRO).
Like Quantitative Easing, LTRO may just be yet another short-term Band-Aid. But that doesn’t mean you can’t ride this wave to a profit in the meantime. LTRO is still in its early stages, and the banks are still taking up more of these three-year loans.
It’s not just Europe. The US Federal Reserve is creating more risk appetite in the market through its policy of low rates for 3 more years.
Bernanke’s hints of QE3 are also adding to this risk-appetite brew. Riskier stocks like small mining stocks perform better than lower-risk, larger stocks in this situation. During the last QE-fuelled rally from mid-2010 to early 2011, small caps did much better than larger stocks. The higher risk Aussie Small Ords index (XSO) rose 30% in the time that the All Ords (AORD) rose 15%.
It’s a potent bowl of punch. The surging Chinese and central bank gold demand, Europe’s version of QE, talk of more QE from the US Fed and 3 more years of low US interest rates … it gives investors the perfect recipe for a big run up in gold explorers that have that certain ‘X-factor’.
Dr. Alex Cowie
Editor, Diggers & Drillers
Publisher’s Note: Dr. Alex Cowie will be appearing at After America: the Port Phillip Publishing Investment Symposium, March 14th-16th at Sydney’s Intercontinental Hotel.
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