Mr. Ben S. Bernanke lived up to the expectation of the gold bugs by launching a massive QE3 program. The dollar weakened and gold surged after the announcement.
This article discusses the outlook for gold keeping in mind the most recent quantitative easing program, the fiscal cliff and the probability of a global recession.
I am of the opinion that gold will witness new highs in the near term (3-6 months) and will continue to trend higher over the long term (3-5 years).
As such, investors can consider having at least 10-15% of their portfolio allocation in gold in order to boost overall portfolio returns. Discussed below are the reasons for this rationale.
The last one-year trend in gold prices has been interesting. Gold price corrected by 19% from September 2011 to January 2012. From January 2012 to early September 2012 (seven months), gold was in a phase of consolidation with the precious metal moving higher by 4.4%.
However, the phase of consolidation seems to be over for gold with the precious metal surging by 8.5% in the last one month. The current uptrend in gold seems like a breakout after a long period of consolidation.
The OMT program launched by the ECB and the QE3 program by the Fed have been the positive triggers for the current breakout in gold prices.
Further, the latest data shows that U.S. consumer prices have increased the most since 2009. Also, U.S. retail sales rose by 0.9% in August 2012 suggesting that the economy might still show ample resilience.
Therefore, the fear of deflation might be overstated. On the contrary, moderately higher inflation might be a bigger challenge in the foreseeable future.
The point I am trying to make is underscored by the surge in 10-year Treasury bond yields. As I write this article, yields have surged by 5% to 1.85%.
The 10-year bond yields have surged to current levels from 1.4% in July 2012. This is more suggestive of an inflationary scenario than a deflationary scenario. Under these circumstances, gold should do well in the near term.
I had discussed the prospects of global QE in one of my earlier articles. The world is already in a manufacturing recession as evident from the global PMI.
In such a scenario, it would not be surprising to see countries like China and India launching stimulus programs in the foreseeable future. This would again be positive for gold prices in the near term.
Therefore, the factors of QE3 and global recession are positive for gold and the precious metal can surge to new highs on the back of these factors over the next 3-6 months.
Looking beyond six months, I expect gold prices to trend higher over the next 3-5 years. In trying to understand the long-term trend for gold, a look into U.S. budget deficits and the expected economic scenario is critical.
With the Fed committing to keep interest rates near-zero levels until mid-2015, it can be understood that economic growth will remain sluggish for a prolonged period. Sluggish economic growth for the next 3-4 years would mean continued quantitative easing, which would support gold prices at higher levels.
In the last four years, the U.S. government has been running deficits of over USD1 trillion. Considering the sluggish economic growth, I expect deficits to remain over USD1 trillion for the next four years as well. I had discussed this in one of my earlier articles.
In other words, I don't expect the fiscal cliff story to play out in 2013 and over the next few years. Tax increases and spending cuts will be delayed in order to support the weak economy.
I had discussed the rationale for no fiscal cliff in 2013 in one of my earlier articles. As such, high deficits will continue to create excess liquidity and would be positive for gold.
I am certainly not suggesting that gold will continue to surge in the next 5 years. Corrections are a part of a secular bull market for any asset class and the same is the case with gold.
However, gold will continue to trend higher and investors can make their portfolio returns attractive by holding gold for the long term.
In conclusion, central bankers around the world resort to quantitative easing in order to prevent recessions and slowdown. With the world still struggling to recover from the worst financial crisis in decades, many more rounds of easing will be witnessed by investors. As long as this continues, the golden era for gold will continue.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.