The Fed’s Balance Sheet Puts Gold and Silver on the Warpath

After remaining calm for most of the summer, precious metals have been on the warpath like they have something to prove. Their move started last month and accelerated with the Federal Reserve’s latest quantitative easing program. The central bank’s third attempt to print prosperity has spurred a new round of balance sheet analysis and gold price targets.

Since the beginning of August, the price of gold has jumped 10 percent, while silver has surged 18 percent. Both precious metals attracted heavy attention and hit a six month high after the Federal Reserve said it would expand its long-term asset holdings by $40 billion each month, in addition to its ongoing extended Operation Twist program. The move will increase the central bank’s balance sheet far beyond its current $2.8 trillion total. In fact, Zero Hedge estimates that by the end of next year, the Federal Reserve’s balance sheet will increase more than $1 trillion to a total of $4 trillion.

The financial site explains, “Beginning January 1, 2013 the Fed will continue monetizing $40 billion in MBS each month, and will continue Operation Twist, however it will adjust the program so that it continues to increase its long-term holdings at $85 billion per month, without sterilization as it will no longer have short-term bonds to sell. It will also need to extend its ZIRP language ‘through the end of 2016’ so all bonds 1-3 years are essentially risk free, as they are now, in effect eliminating the need to sell them.” In other words, “The Fed will therefore monetize roughly half of the U.S. budget deficit in 2013.”

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Bank of America also made similar predictions, but expects the Federal Reserve to take additional monetary action until the end of 2014, due to the weak labor market. The bank estimates that the Fed will end up owning more than a third of the total outstanding mortgage market by the end of 2014, and roughly half of the long end U.S. Treasury market in a year. Naturally, this is seen as a huge positive catalyst for gold prices.

Francisco Blanch, a global investment strategist with Bank of America, recently placed a price target of $2,400 an ounce on gold by the end of 2014. In a report called “Gold Under QE-Infiniti,” he explains, “The new target reflects our view that the Fed will maintain mortgage purchases until the end of 2014, and will move to buy Treasuries following the end of Operation Twist this coming December.” He later adds, “The combination of open-ended MBS purchases and the possibility of additional Treasury bond purchases starting in December could further lift gold prices by adding over $2 trillion to the Fed’s balance sheet over the next two years.” Meanwhile, Deutsche Bank believes gold prices will hit $2,000 an ounce in the first half of 2013.

An additional $2 trillion on the Fed’s balance sheet would push it to a whopping $5 trillion, in what will certainly go down in the history books as the greatest fiat currency experiment of all-time. Unfortunately, history favors money that can not be easily printed by central banks.

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Disclosure: Long EXK, AG, HL, PHYS