Anyone following closely the action in the precious metals markets today would probably have noticed a sharp reversal in the prices of both gold and silver. Does it mean that the rebound is over in the precious metals market?
It depends on the perspective each investor holds regarding the short-term and the long-term effects of Quantitative Easing (QE) on the prices of the two metals.
For more than five years, QE has been the milk that feeds the precious metals rally. Especially gold, which has been seen as a safe haven for the currency devaluations and the prospect of runway inflation that undermines the value of money.
While this thesis is correct for the short term, as additional bank reserves eventually flow to all sort of assets, including precious metals; it is wrong in the long term, as QE fails to stimulate growth and inflation.
Major Precious Metals ETFs / Stocks
5-day Performance (%)
3-Month Performance (%)
5-year Performance (%)
SPDR Gold Shares (GLD)
iShares Silver Trust (SLV)
Freeport-McMoRan Copper & Gold (FCX)
To explain why this is the case, we must first understand an important difference between conventional monetary policy and QE.
Conventional monetary policy works through the money markets, pushing down the cost of credit for everyone - including the middle-lower class. This stimulates aggregate spending which, once aggregate spending exceeds full capacity, eventually creates inflation.
That's the bullish case for holding gold.
QE, by contrast, works through the capital markets, pushing the cost of credit down for the middle-upper class, which owns several assets.
Most notably, the impact of QE on asset values is different in short term and long term. In the short term, the Fed's purchase of long-term securities is bullish for all asset categories -- including gold, as investors move money away from safe-low interest-bearing assets to risky assets.
In the long term, however, QE fails to boost aggregate spending, as it doesn't reach the lower-middle class people who do not own a home or have a great deal of funds in retirement accounts.
That's why QE has failed to generate inflation so far. And it is a bearish case for gold, which gold bugs have discovered the hard way.
What should investors do at this point?
It depends on the investment horizon of each investor. Short-term investors may want to trade precious metals on the long side, given the big correction of the last three months. Long-term investors must keep an eye on the one variable that matters in the end: Inflation.
Here is what you need to know before you trade precious metals: The difference between conventional monetary policy and Quantitative Easing.