Why gold’s not running up as fast as it can

Gold is on a roll. Again!
The price of the yellow metal has risen 7% since August 1 and is currently quoting at $1,735 per ounce (one ounce equals 31.1gram). In fact, just since August 31, the price of gold has risen by around $60, or 3.7%.

Still, the price is nowhere near how high it could go. All thanks to the US Presidential elections, as we will see here.

Today, it is widely expected that the US Federal Reserve (Fed), the American central bank, will soon carry out another round of quantitative easing (QE) — that’s the big reason for the spurt.
QE is a technical term that refers to the Fed printing dollars and pumping them into the American economy.

“Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labour market conditions in a context of price stability,” Ben Bernanke, the current Fed chairman, said in a speech titled Monetary Policy since the Onset of the Crisis at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, on August 31.
Fed chairmen are not known to speak in simple English. What Bernanke said is, therefore, being seen as Fedspeak for another round of easing.

Interestingly, in a speech he made at the same venue two years earlier, on August 27, 2010, Bernanke had said, “We will continue to monitor economic developments closely and to evaluate whether additional monetary easing would be beneficial. In particular, the committee (Federal Open Market Committee, or FOMC) is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly.”

The two statements bear an uncanny similarity to each other. Bernanke’s August 2010 statement was followed by the second round of quantitative easing, in which the Federal Reserve pumped in $600 billion of new money into the economy.

QE2, as it came to be known as, started in November 2010.
Between August 2010 and beginning of November 2010, gold prices went up by around 9% to around $1,350 per ounce. QE2 went on till June 2011, and by then gold had touched $1,530 an ounce.

No wonder the market is now expecting another round of easing — QE3 if you please.

To be sure, the Fed has been hinting at another round of QE for a while now. At its last meeting, held on July 31 and August 1, the FOMC said in a statement, “The Committee will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labour market conditions in a context of price stability.”
Mark the phrase “additional accommodation”, which is a hint at another round of easing.

Gold has rallied 7% since then. 

But these hints haven’t been followed by any concrete action, primarily on account of the fact Mitt Romney, the Republican candidate against the current US President, Barack Obama, has been highly critical of the Fed’s quantitative easing policies.

“I don’t think QE2 was terribly effective. I think a QE3 and other Fed stimulus is not going to help this economy… I think that is the wrong way to go. I think it also seeds the kind of potential for inflation down the road that would be harmful to the value of the dollar and harmful to the stability of our nation’s needs,” Romney told Fox News on August 23.

Paul Ryan, Romney’s running mate, echoed his views, when he said, “Sound money… We want to pursue a sound-money strategy so that we can get back the King Dollar.”

The theory behind quantitative easing is that with more money in the economy, banks and financial institutions will lend that money and businesses and consumers will borrow. But both American businesses and consumers have been shying away from borrowing. Hence, all this money floating around has found its way into stock markets around the world.

As more money enters the stock market, stock prices go up and this creates the “wealth effect”. People who invest money in the market feel richer and then they tend to spend part of the accumulated wealth. This, in turn, helps economic growth.

As Gary Dorsch, an investment newsletter writer, said in a recent column, “Historical observation reveals that the direction of the stock market has a notable influence over consumer confidence and spending levels. In particular, the top 20% of wealthiest Americans account for 40% of the spending in the US economy, so the Fed hopes that by inflating the value of the stock market, wealthier Americans would decide to spend more. It’s the Fed’s version of “trickle down” economics, otherwise known as the “wealth effect.””

That suggests the economy is likely to grow faster and hence, people are  more likely to vote for the incumbent President.
Given this, Romney has been a vocal critic of quantitative easing, knowing that another round of money printing will clearly benefit Obama.

But Bernanke is unlikely to start another round of quantitative easing before November 6, the day the Presidential elections are scheduled, because he might end up with Romney as his boss.
Currently, most opinion polls put Obama ahead in the race. But the election is still two months away, a long time in politics.
Romney has made clear his views on Bernanke by saying, “I would want to select someone new and someone who shared my economic views.”

This has held back the price of gold from rising any faster.
As such, any round of quantitative easing ensures that there are more dollars in the financial system than before. And to protect themselves from this debasement, people buy another asset --- gold --- something that cannot be debased.

During earlier days, paper money was backed by gold or silver. When governments printed more paper money than they had precious metal backing it, people simply turned up with their paper at the central bank and demanded it be converted into gold or silver.

Now, whenever people see more and more of paper money, the smarter ones simply go out there and buy that gold.
So, all eyes will now be on Bernanke and what he does in the days to come. From the way he has been going, there will surely be some hints towards QE3 in the next FOMC meeting, scheduled for September 12-13.

Kaul is a writer and can be reached at vivek.kaul@gmail.com