The recent publication of the minutes of the FOMC meeting reignited the bullion market. Many expect that the Fed will introduce another quantitative easing plan that will expand the Fed's balance sheet and thus raise the money base. This news is likely to rally gold and silver prices. By extension, this could also mean that if the U.S. monetary base will continue to expand, the prices of SPDR Gold Shares (NYSEARCA:GLD) and iShares Silver Trust (NYSEARCA:SLV) will also trade up. Despite the recent shift in market sentiment, I have a couple of comments worth considering that could curb the rally of bullion if the FOMC will launch QE3.
There is a strong and positive relation between gold and the U.S. money base: As the money base rises, the price of gold tends to increase. The U.S. monetary base rose in the past couple of months -- during July by 2.85% and during August by 0.5%. This news alone implies that gold might continue rising during August and September.
Furthermore, the Fed published the minutes of the latest FOMC meeting yesterday. In the minutes there are indications that FOMC members are considering introducing another stimulus plan.
From the minutes:
Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.
This news has already affected the bullion market, as both gold and silver are currently hiking.
The following chart shows the changes of gold prices (monthly average prices) and the U.S. monetary base between 2008 and 2012 (up to August). According to the chart, the U.S. monetary base rose during the past couple months, which might partially explain the modest growth in gold price during those months.
Click to enlarge image.
Furthermore, the relation between the lagged by one month of the U.S. money base (monthly percent change) and gold prices is positive and mid-strong. Between January 2009 and August 2012, the linear correlation between these two data series was 0.34. This relation suggests that if the U.S. monetary base will continue expanding, gold price might further rise. The minutes of the FOMC meeting could imply that in the near future there will be another monetary expansion that will pressure up bullion prices, as was the case in the past.
In regard to this, I have two comments:
- There could be diminishing return to the next quantitative easing, assuming it will be at the same amount as each of the first two QE programs. In other words, the impact QE3 will have on the economy could be less effective than the first two.
- If QE3 causes the gold and silver market to reheat, as was the case in QE1 and QE2, the CME might intervene again as it did in 2011 by raising the margins on gold and silver contracts that will curb the bullion rally.
As many have already stated, another QE program will likely rally gold and silver, but there are some pullbacks that could curb their recovery.
For further reading: "Gold And Silver Outlook For August."
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.