It has been an interesting year thus far for gold. Having traded between USD$ 1600 to USD$ 1800 for much of last year, it has trended downwards for the first few months of this year, cumulating in a nose dive in the middle of April, where prices tumbled 15% in a mere 2 days and is currently trading around USD$1,400.
One of the main contributing reasons many agree on is the ongoing talk by the United States Federal Reserve to taper quantitative easing, with some suggesting a tapering starting as early as the end of this year. The reason offered was that the amount of money that has been pumped into the economy has already started to stimulate the economy and since this is the case, the government do not have to interfere in the markets anymore. Other reasons that were offered included the slowdown in the Chinese Economy or the hedge funds liquidating their long positions in the stock markets.
What implications are there should the Federal Reserve slow down the printing of the dollar? The dollar will definitely increase against other currencies, which is what we have already seen as investors move their money out of other asset classes (gold and silver included) to invest in the US dollar and their stock exchanges. For example, the S&P 500 has been up around 16% since the start of the year.
This outflow of money from gold and silver into US dollar and its stock exchanges is likely to cause prices of gold and silver to fall. Does that mean that we should steer clear of physical precious metals? Investors might have forgotten two very key issues. Firstly, even though we have not seen it thus far, all the money that has been generated so far will definitely contribute to inflation in the mid to long term and this will result in the further weakening of the dollar. Investors who therefore want to protect themselves against this inflation is likely to buy into precious metals, especially when the prices are trading at much lower than their peaks.
Secondly, investors might have missed the point that even if the Federal Reserve taper quantitative easing or stop them completely, it does not change the fact that the United States still owes the world more than USD $ 16tn and this amount is increasing every single day due to new debt as well as the amount incurring interest. To give you an idea how severe this level of debt is, consider the gross domestic product of the United States. It currently collects around USD $15tn per financial year and most of this amount has to be spent on day to day issues like education, military defense and social security just to name a few. Unless there are significant changes to the amount of money that the United States collect, it is highly unlikely that they would have any extra money to pay down their level of debt.
Despite the complexity and intricacies of economics and finance, there is one thing that is very simple to understand and everyone will agree. Money borrowed has to be returned, one way or another, sooner or later.With the current debt that the United States is facing and the amount of money they are bringing in currently, they only really have a few options that they could do.
Firstly, they could look at increasing the amount of money that they bring in, which means that they could potentially look at improving output and hence exports. However, this might prove to be a challenge with the rise of other economies like the BRICs (Brazil, Russia, India and China). Secondly, they could of course choose to print more money to pay their earlier debt, which would bring us back to square one once again. Lastly, and the most undesirable, would be that the United States would default on their debts to the rest of the world and cause a financial meltdown worldwide. One of the assets whose prices would soar would be the physical precious metals as this is an asset that has stood the test of time and retained it’s value for many, many years. Its current fall in prices makes no sense at all given its strong fundamentals.
In the current supposed boom in the global financial markets, one must carefully consider the implications of what the governments are doing and then make informed decisions.