HardAssetsInvestor

Written by Amine Bouchentouf  |

September 19, 2012

The Commodity Investor: QE3 Can Certainly Boost Gold To $2000/oz, But Calls Of $5000 & $10,000 Are Whimsical

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What should gold investors expect from QE3? Higher prices, yes, but some forecasters are getting carried away with fanciful upside projections.

Few gold investors were taken by surprise when the yellow metal surged on the Federal Reserve’s third round of quantitative easing announced last week. The positive impact QE3 has on gold is a basic fundamental; just look at gold’s reaction to previous stimulus measures initiated by the Federal Reserve.

After QE1 was announced in the wake of the financial crisis, gold prices increased 36 percent; during QE2 announced in November 2010, gold prices shot up 21 percent. There are many macroeconomic and econometric models that indicate a direct relationship between gold prices and the monetary base, which is usually measured as money supply M0 and M1.

The models indicate that an increase in money supply tends to increase the price of gold. At its most basic level, quantitative easing programs tend to increase the money supply; in addition, more dollars injected into the system tends to decrease the value of the dollar.

All else being equal, as the value of the dollar decreases, the value of gold and other dollar-denominated assets tends to increase. This is one of the many important reasons why gold prices increase during and after bouts of quantitative easing. And we don’t expect gold to react any differently this time around.

Gold At $2000?

Many commentators and analysts are now predicting that gold will be reaching $2000/oz.; some are even arguing that gold may reach these levels before the end of the year. The position of The Commodity Investor is that the upward trend for gold prices has been established after a period of consolidation that lasted for most of the summer. Let us take a look at what gold has done so far in 2012 in order to determine what gold will most likely do as the year comes to a close.

Gold began the year on a very positive note, rising more than 8 percent between the beginning of January and the end of February. While the first two months of the year proved to be good for those who were long gold, the subsequent months weren’t as generous.

Between the months of March and July, gold prices were down almost 11 percent. It was also not a good time to be long gold during the summer; it certainly was not a good time to exit any positions since that period marked a yearly low. Indeed, prices almost hit $1500/ounce in May and June. For a period of time, it looked as if the stock market mantra of “Sell in May and Go Away” also applied to gold.

However, as the summer doldrums subsided, gold prices began to show signs of life once again. While the months of March, April, May, June and July experienced decidedly mild downward swings, the month of August marked the beginning of the consolidation period. Up until the middle of August, we did not get any strong indications of price action in either direction.

This of course changed toward the end of August, as prices began an upward-biased trend. And the trend was confirmed as prices exploded in September, up almost double digits since the August lows—indeed, prices are currently up 10 percent since Aug. 1.