If there is one lesson that investors have learned in recent years, it is don’t fight central banks. The rally seen in equities since the lows of 2009 is now considered one of the most hated rallies in history. Analysts and pundits can debate macroeconomic conditions until blue in the face, but when central banks inject trillions of dollars into the financial system, the general trend tends to be higher. Precious metals have also benefited from monetary easing programs, but they are now finding out how hard it is to fight central banks.
While some people have a love or hate relationship with gold, the precious metal itself is much closer to a lover than a fighter. Since 2009, the price of gold has rallied from about $850 to $1,600 an ounce today. Through programs such QE1, QE2 and zero interest rates, gold was able to reach a nominal record high just above $1,900 last year. Meanwhile, silver reached as high as $49 in April 2011. However, both precious metals have struggled recently as central banks rely more on jawboning and confusion, rather than official stimulus programs.
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Despite weaker-than-expected economic reports, the Federal Reserve has not launched another massive bond buying program. In the central bank’s most recent Federal Open Market Committee statement, it noted the elevated unemployment levels and decelerated economic activity, but simply said it “will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.” Across the pond, Mario Draghi, president of the European Central Bank, recently declared that the central bank is “ready to do whatever it takes to preserve the euro, and believe me, it will be enough.” Many interpreted the statement to signal that immediate action were to come from the ECB, but no such action has been taken.
Instead of trying to decode jawboning or fight central banks’ inaction, gold has simply waited patiently on the sidelines. As the chart above shows, the precious metal has been trading in a relatively tight $100 range between $1,540 and $1,640 for the past three months. In fact, gold has become so boring recently, the open interest in gold futures is at its lowest in nearly three years. However, investors should not forget that many central banks around the world are still interested in gold. Last year, central banks purchased more than 400 tonnes of gold, the most in nearly five decades, according to the World Gold Council. In July, South Korea, the world’s seventh largest forex reserves holder, reportedly bought 16 tonnes of gold.
Although precious metals appear to be out of favor by its narrow trading range, history shows that central banks are likely to resume large money printing programs sooner, rather than later. Operation Twist has already been extended through the rest of this year, and the Fed is currently experimenting with repurchase agreements, which are collateralized loans to primary dealers in order to inject more liquidity into the financial system. Last week, the central bank added $210 million in reserves by repos and followed up it up with another $600 million this week. Zero Hedge notes that “repos are liquidity injecting, and while the Fed may promise these are merely test runs, everyone knows they are anything but, and are merely a telegraphing to the banks of what is in store.”
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Disclosure: Long EXK, AG, HL, PHYS