A Test of Strength for Gold

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Recently by Frank Holmes: 4 Sensational Facts About Gold Investing That You Might Not Know

     

When investing in gold, I often say diverse opinions promote critical thinking and a healthy market. I believe elevated groups of buyers and sellers create a competitive tug-of-war in the bid and ask price of the precious metal.

Last week, we saw the gold bears growling louder and gaining strength, as the world’s largest gold-backed ETF, the SPDR Gold Trust, experienced its largest one-day outflows since August 2011. The Fear Trade fled the sector following the Federal Reserve’s meeting that revealed a growing dissension among some of its members over the central bank’s bond-buying program.

Despite the discord, the Fed is continuing its course to purchase $85 billion of bonds every month and keep interest rates near zero. Ben Bernanke’s plan bloating the balance sheet to more than $3 trillion has been keeping the Fear Trade coming back for more metal.

For good reason, too, as the correlation between the Fed’s balance sheet and the price of gold has historically been very high, at 0.93, according to Macquarie Research. The firm found that for every $300 billion expansion in the balance sheet of the U.S. government, there was a $100 an ounce increase in the price of gold. When you factor in the Fed’s current bond purchases totaling $85 billion per month for the next nine months, the central bank will be adding $765 billion in new assets. “Using the previous ratio, this would compute to a $255 an ounce increase in the gold price,” says Macquarie. By this measure alone, gold would rise approximately 16 percent over the next several months.

On Bloomberg’s Taking Stock with Pimm Fox on February 22, I said that Bernanke will likely keep liquidity high for quite some time, in his effort to meet his goal of lowering the unemployment rate. If the Fed did take its foot off the bond-buying pedal sooner than planned, such a move is apt to shake the resolve of some gold buyers. It’s easy to be confident in gold in times of extreme fear; when the economy improves, one may no longer feel that gold stands on solid ground.

Take another period characterized by extreme volatility and fear, when there was conflict in the Middle East, oil-related inflation shocks, declining value in the U.S. dollar, rising U.S. unemployment and a strong resolve from the Fed to act aggressively. This was four decades ago, after President Richard Nixon removed the gold standard, and the yellow metal climbed to a peak of $850 by January 1980.

Back then, India and China had little financial footing in global markets; gold demand from these areas of the world was about 15 percent of total demand.

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Frank Holmes is chief executive officer and chief investment officer of U.S. Global Investors Inc. The company is a registered investment adviser that manages approximately $4.8 billion in 13 no-load mutual funds and for other advisory clients. A Toronto native, he bought a controlling interest in U.S. Global Investors in 1989, after an accomplished career in Canada's capital markets. His specialized knowledge gives him expertise in resource-based industries and money management.

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