Gold Prices Edge Higher On Fiscal Cliff Deal

Includes: GLD
by: StockRiters

Gold prices have risen sharply in trading today after the U.S. Congress passed a bill that averts huge tax increases and spending cuts.

The Fiscal Cliff Deal

After over a month of political bickering, lawmakers finally reached a budget deal late Tuesday. The Senate passed a compromise bill called American Taxpayer Relief Act of 2012 early on January 1, 2013, few hours after the deadline for reaching a deal expired. Late Tuesday, the bill was also passed by the Republican dominated House of Representatives by a margin of 257-167. President Obama has said that he will pass the bill into a law.

The budget deal would see the expiration of Bush-era tax cuts for individuals earning over $400,000 and couples earning over $450,000. The tax rate on income over those amount has been raised to 39.6% from 35%; the deal would also see the expiration of two-year-old cut to payroll taxes; an increase in taxes on capital gains and dividends from 15% to 20% for individuals earning over $400,000 and couples earning over $450,000; an increase in tax rates on estates worth over $5 million; a phase-out of certain deductions and credits for individuals earning over $250,000 and couples earning over $300,000; a delay to budget sequestration by two months; an extension of some tax credits for poorer families; and an extension of federal unemployment benefits.

While the fiscal cliff has been averted for now, the budget deal does not end the uncertainty. Lawmakers have failed to reach a deal on U.S. debt ceiling, which was reached on Monday. The U.S. government will require approval from Congress to raise the debt ceiling in the next two months. Also, the deal does not address the issue of longer-term spending cuts. Until these issues are resolved, there will be uncertainty in the market.

Gold Gains on Partial Deal

Gold prices have edged higher in trading today as investors cheer the budget deal. At last check, spot gold was trading $15.56 higher at $1,690.10 an ounce. Gold futures for delivery in February on the Comex division of the New York Mercantile Exchange were up $10.90 to $1,686.70 an ounce.

Ole Hansen, Vice President of Saxo Bank, told Reuters that the deal does not seem like a long-term durable solution to the U.S. debt but it has given the gold market the excuse to move higher, helped by the dollar.

It may be recalled that gold prices had come under pressure in the last few days of 2012 amid uncertainty due to the fiscal cliff issue. Still, the precious metal managed to post its 12th straight annual gain in 2012.

12th Straight Annual Gain

Gold posted its 12th straight annual gain in 2012, finishing the year nearly 7% higher. However, the precious metal will post its lowest return since 2008. Gold's return in 2012 was lower than the S&P 500, which finished the year 13.41% higher. The SPDR Gold Trust ETF (NYSEARCA:GLD), the world's biggest gold-backed exchange traded fund, gained 6.6% in 2012.

2012 turned out to be a volatile year for gold investors. The precious metal began the year on a strong note; however, shed some of its gains in the first half as it appeared that the Federal Reserve was not prepared to implement additional monetary easing measures.

Gold peaked at the end of February 2012, extending its gains from the previous year. However, bullish bets dried up after that as hopes of further monetary easing from the Fed diminished. Also, the euro zone debt crisis weighed down sentiment on gold.

Market sentiment turned bullish on gold in late August amid speculation that the Federal Reserve will launch a third round of quantitative easing. Gold also gained as concerns over the euro zone debt crisis eased after European Central Bank (ECB) President Mario Draghi said in June that within its mandate, the ECB was ready to do whatever it takes to preserve the euro.

Meanwhile, gold continued to strengthen as speculation rose that the Fed will launch a new bond buying program. The speculation was fueled further by Federal Reserve Chairman Ben Bernanke's statement at the central banks' meeting in Jackson Hole, Wyoming, at the end of August. The Fed Chairman said that the Fed was open to another round of quantitative easing if needed.

Bullion investors didn't have to wait long for additional easing measures as soon after the statement in Jackson Hole, Wyoming, the Fed at its next monetary policy meeting launched a third round of quantitative easing. QE3, as the third round of bond buying program, turned out to be more aggressive than investors' expectations as the Fed said that it would buy $40 billion in mortgage backed securities every month, until there is a sustained recovery in the labor market.

Gold rallied on QE3, rising close to its February higher, however, pulled back once again ahead of the U.S. Presidential election. The precious metal once again picked up momentum following the re-election of President Obama, who has backed Bernanke's ultra-loose monetary policy.

In last few weeks of the year, gold once again saw a pullback, falling to a four-month low two weeks ago, amid concerns over the fiscal cliff. Gold saw a correction even as the Fed announced another round of quantitative easing to replace Operation Twist at its most recent FOMC meeting.

So Where is Gold Headed in 2013?

While gold posted its 12th straight annual gains in 2012, its performance was disappointing when compared to recent years. So is this the end of rally in gold? Not really.

Gold's recent correction has been due to concerns over fiscal cliff. The partial deal reached on Tuesday will help gold prices; however, uncertainty due to the debt-ceiling issue could keep a check on prices. However, gold's fundamentals remain strong, and this means that the precious metal is likely to post gains in 2013.

Firstly, monetary policy in the U.S. is likely to remain accommodative in 2013. The Fed has already hinted that it is no rush to tighten monetary policy soon, provided that inflation remains under control. And Fed is not the only central bank that is likely to continue with accommodative monetary policy. The Bank of Japan and ECB are also expected to continue with monetary easing measures.

In a research note earlier this year, Bank of America analysts said that they expect large-scale policy easing by the Fed and the ECB to push gold prices higher.

Apart from accommodative monetary policy, central banks' buying of gold is also expected to support prices. In the third quarter of 2012 alone, central banks bought 97.6 tons of gold, according to data from the World Gold Council.

Physical demand for gold in India is expected to rebound, according to the World Gold Council. Chinese gold demand, meanwhile, expected to grow around 10% in 2013, the World Gold Council's Managing Director, Marcus Grubb, told Reuters in an interview recently.

Given all these factors, gold is poised to post its 13th straight annual gain in 2013.

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.