While it hasn't been dubbed QE3 yet, the coordinated actions by the world central banks including the U.S. Federal Reserve this morning may have opened the floodgate again. The coordinated efforts, which were driven by funding strains faced by European banks, may have stemmed a modern day "run on the banks."
Whereas in June, the 3-month LIBOR hovered close to the 0.25% rate the Fed pays on excess bank reserves, it was today at 0.53%, indicating banks were having increased difficulty obtaining dollar funding. We believe policy makers continue to focus on our debt crisis with liquidity measures.
With virtually no help from politicians from a fiscal standpoint, central bankers are again forced to “save the day,” so to speak. Markets around the world rallied hard on the news of central bank intervention. Our view stands that this simply means more can kicking and monetary easing which picks the pockets of savers. Swap lines will remain open at current levels until early 2013.
We recently outlined an article stating that we believe gold would perform well if and when the Federal Reserve engages in more quantitative easing (Buy Gold Ahead Of QE3). Wednesday’s central bank intervention is a stealth easing. The use of the Fed’s swap facility expands the Fed’s monetary base. Any time a foreign central bank engages in a swap with the Federal Reserve, the Fed will create new money in order to make the swap. Use of the Fed’s liquidity swap line in late 2008 was the main cause of a surge in the Fed’s monetary base at that time. The peak for the swap line was about $600 billion in December 2008.
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We think this is a shock and awe moment for the central banks. The response has been liquidity and more money printing. We are advocating owning precious metals in a time in which our only solution seems to be printing more money. Today, the U.S. monetary base is only backed 15% by gold.
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When gold was in “bubble” territory in the 1980s, gold reserves as a percentage of the money supply was over 100%. With the current policy glide path, gold could experience a meaningful uplift in price.
Gold Performance During QE1 and QE2
QE1 and QE2 lasted for 15 months and 8 months, and gold was up 36% and 21%, respectively, during these periods.
We own gold and silver in physical and ETF forms (GLD and SLV). We follow a policy of not timing the market, but slowly accumulating these metals, as they are our insurance policy against inflation. Investors interested in vehicles that retain physical metal should look into Sprott Asset Management’s Sprott Physical Gold Trust (NYSEARCA:PHYS) and Sprott Physical Silver Trust (NYSEARCA:PSLV).
Disclosure: I am long GLD, SLV.
Additional disclosure: Also long physical gold and silver.