On December 17th I posted a letter I wrote to the authors of a Barron's article on the Fiat Gold blog. At the time, I was focused on just how diametrically opposed the views were in just the first two articles of that week's paper. I pointed out that what was different between the two views was not whether Europe would recover (both believed there was no soft landing), but rather the method through which they would address the issues confronting them. Would it be a process of deleveraging and economic austerity, or a money printing fest with inflated money being used to pay down the excessive outstanding debt? At the time gold was not being viewed as a safe haven. On days where bad news hit and the stock market tanked, gold would tank too. The golden rule is that money printing should be bullish for gold, but "bad news" did not appear, like it has been in the past, to serve as an impetus for gold prices going higher. Over the past few weeks, we are starting to see a few things take place which are showing that the bull case for gold going forward is still in tact despite a 25+% retracement toward the end of last year.
Today, as has been the case at least three times now this year, Gold rallied as the US dollar rallied. Often, when the dollar is strong, gold will sell off because it becomes cheaper in dollar denominated terms. To see that gold can perform positively as it did today, despite this is encouraging. While the stock market has been trading higher, we saw gold futures trading up this morning while stock futures were lower. Gold began trading in lock step with equities before breaking down on our last move lower. To see it trading under different market conditions (up when the stock market is down, up despite a stronger dollar etc) shows that there is demand for gold independent of some obvious correlation.
Market observation aside, the fundamental case for bullish gold is that it thrives in an inflationary environment. Despite European talks of austerity, Pimco's Bill Gross talks about what is going on right beneath our noses, which is really quantitative easing at its heart. I should point out (and the letter is really worth the read http://www.pimco.com/EN/Insights/Pages/Towards-the-Paranormal-Jan-2012.aspx) that Gross is not saying that money printing will be the inevitable inflationary way out of Europe. He leaves room for the "fat left-tailed" scenario of delevering as a strong possibility and even says that "gold at $1550 seems pricey, but it has upward legs if QEs continue". Earlier in the paper he discusses the racket that is the Italian bond market. Italian banks are issuing government guaranteed paper, and taking the proceeds and investing them in Italian sovereign bonds. This is a nice way to prop up the banks and the government bonds, especially considering that banks are receiving approximately 7% on 10 year paper. Of course, the fact that even with this scam going on yields are as high as 7% is very disconcerting. I however, am focused on the fact that this is classic unadvertised quantitative easing taking place. The government is not buying their own bonds, but rather facilitating the purchase of its bonds by someone else. The end result is essentially the same. QEs are good for gold.
Now perhaps these quantitative easing do take place, and for reasons you can read in the Gross piece, more money supply does not lead to inflation. We have learned post 2008 that easing the monetary supply does not ensure lending will take place, as Gross points out due in part to the flatness of the yield curve. If easy monetary policy fails, then maybe taking down leverage in the system will inevitably be the only way out. It is clear, however, that quantitative easing is covertly taking place already, and will run its course before we reach the point where it is determined ineffective. With a backdrop like that, and gold maintaining its long term uptrend as well as breaking above its 200 day moving average, the bull scenario is in full swing.
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