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Gold: Can It Only Rise On Stimulus?
Gold has been a consistently strong performer since the early days of the financial crisis. But while the long-term fundamentals behind the trade remain firmly intact, the Gold price has fallen flat over the last several months. Despite the recently choppy price performance, it is likely that Gold may soon be entering the next sustained phase higher. And like so many other asset classes, the final outcome will be heavily dependent on actions by monetary policy makers.
A primary appeal to owning Gold in the current environment is its multifaceted characteristics. In short, it performs well at economic and market extremes. This includes periods of adrenaline induced market euphoria brought on by periods of aggressive monetary stimulus and its accompanying inflation risks. This also includes periods of perceived crisis and extreme market distress that have quickly followed once these central bank stimulus programs concluded, as Gold serves as a store of value versus fiat currencies during times of potential instability.
Until recently, Gold provided results that were consistent with expectations. It steadily rose during the Fed’s QE1 and QE2 stimulus programs. And it continued to rise once these programs ended and the stock market (SPY) quickly plunged along with the outlook for the economy.
But starting in late September 2011, Gold entered into a choppy sideways grind. Given that global central banks are still stimulating and the threat of economic crisis is as profound as ever, this raises an important question.
What seems to have caused Gold to lose its previous strength in recent months?
The answer is Operation Twist. Looking back, Gold recoiled from the very moment that the Fed first announced Operation Twist back in late September 2011. And since that time, Gold enjoyed one sustained period of acceleration. This began the moment the European Central Bank (ECB) launched its own Long-Term Refinancing Operation (LTRO) in late December 2011 and ended precisely when the ECB concluded this program at the end of February 2012.
A closer look at the numbers highlights this point. While the Gold SPDR (GLD) is used for the following analysis, the same principles apply for the iShares Gold Trust (IAU), the Sprott Physical Gold Trust (PHYS), the ETFS Swiss Physical Gold Shares (SGOL) and the Central Gold Trust (GTU).
During the Operation Twist only period from September 21, 2011 to December 20, 2011, Gold returned -9.6%.
During the combined Operation Twist and LTRO period from December 21, 2011 to February 28, 2012, Gold returned +10.4%.
And since February 29, 2012 when LTRO ended and we reverted back to an Operation Twist only environment, Gold has returned -12.6% through May 23.
So what is the key difference with Operation Twist that is likely causing Gold to underperform? The answer: explicit central bank balance sheet expansion. During the Fed’s QE1 and QE2 as well as with the ECB’s LTRO, the respective balance sheets were expanding dramatically. But while the composition of the balance sheet is changing dramatically under Operation Twist, it is not technically expanding.
It seems that Operation Twist leaves Gold suspended in an uncomfortable state of limbo. The economy and markets are receiving just enough monetary support to hang in there, but not enough to lead to any euphoric extremes. After all, if you remove the ECB’s LTRO period mentioned above, the stock market has slowly faded during the combined Operation Twist only periods once the initial pop back in October 2011 wore off. Thus, the performance of the Gold price has been left uninspired in such a languid backdrop.
With all of this being said, now is not likely the time to exit the Gold trade. Instead, we may soon be entering the next move higher in Gold. First, it currently appears set to complete a double bottom technical pattern. But more importantly, we may also soon be entering the next phase of perceived crisis and extreme market distress. The Fed’s Operation Twist is scheduled to end in June and concerns are mounting that Greece may finally opt to exit the Euro Zone as soon as the coming weeks, which has the potential to spark another global financial contagion. And it is during periods marked by such extremes where Gold has shown the ability to shine in recent years.
If markets plunge back into crisis once again and the Fed is alone in launching Operation Twist 2, Gold may return to chopping sideways. But if the Fed opts for another round of QE and/or the ECB joins with another round of LTRO, Gold will have the fuel to take any crisis induced advance to the next level.