Our 2013 short call on gold looks to be proving rather prescient already…

In the latest edition of our magazine that is just out, we have made what is a brave call on shorting gold for 2013, principally based on an earlier exit from the loose monetary policies and quantative easing measures by the Fed ending sometime before the market currently thinks. Well, in the minutes of the FOMC yesterday, some of the Fed members duly obliged and confirmed our views (see below underlined and in bold) with comments that they’d like to end the extraordinary measures this year. 

• FED SAYS A FEW ON FOMC WANTED QE UNTIL ABOUT THE END OF 2013
• FED: SEVERAL ON FOMC BACKED QE HALT OR CUT WELL BEFORE 2013 END
• ALMOST ALL FOMC MEMBERS SAW POTENTIAL QE COSTS AS INCREASING

With gold down nearly $50 from the high’s yesterday, we’d recommend all our readers take a look at our reasoning. Here’s the snippets from the magazine piece, to read it in full, click the image on the Home page and go directly to Commodity Corner (Page 93): – 

It seems that many of the gold bulls have forgotten the simple laws of supply and demand and, at a physical level, demand for gold has been waning in the last 18 months with Indian and Chinese market participants openly stating that the current spot price is too high. This leaves financial demand from ETF’s and investment funds (and of course John Paulson!) to support prices. With the exit from the extraordinary monetary easing in sight in the US following continued evidence of strength in the economy, movements in interest rate futures in the US are our smoke signal that gold is likely to retrace at least half the gains seen during the last 15 years (a typical retracement of a bull run) and revert back to $1000-1200 which is, of course, where physical demand comes in again…

Selling begets selling too, and should gold take out the $1600 level, then we’d expect a crescendo of selling by the investment and hedge funds that are carrying the bull positions as the trend reverses decisively. Remember too that gold pays no yield and so when holding gold you actually have real carrying costs of storage and insurance. The only return to those exposed to gold is capital return and so if gold falls in price there is no reason to hold.

Quantitative Easing & the End Game

In order to fight the raging global economic fire that was the Great Financial Crisis occurring 2007/8, Central Banks embarked upon what any good fireman would do to extinguish a fire — they doused the global economy with liquidity. Interest rates came down to near zero levels and massive asset purchase programs were announced. The U.S. Federal Reserve alone is now on its third round of quantitative easing and is expected to inject in excess of another trillion dollars into the domestic economy through more bond purchasing. The FED’s balance sheet now runs to over $3tn.

There are unmistakable signs in the US that QE and its dampening effect on mortgage rates is having a positive effect on the housing sector, although its effect on stock prices has been much more muted of late. The FED is able to continue with the liquidity spigots fully open as the inflation bogeyman has yet to rear its head, and so “Helicopter” Ben still has latitude to ease. Indeed, the employment market in the US has begun to stir again during the last 18 months. One thing is for sure, however, and that is if the housing and labour markets continue on their current trajectory, then, ultimately, and perhaps sooner than the market thinks, this will ignite inflation. And this is the central fundamental point of our bearish stance on gold — the US monetary easing program is closer to the end than the beginning and we expect in late 2013 (a full 18 months ahead of the markets current expectations) that the FED will begin to exit their QE programs and nudge interest rates up. This will be a hammer blow to gold as the relative attractiveness of bonds, in particular, increases with higher yields. After all, why hold a non-income producing asset that actually costs you to hold, particularly when the capital growth side has vanished?