After months of waiting, the European Central Bank (ECB) finally
carried through with its stated promise of unlimited monetary support to its
ailing economy. The ECB announced its own version of quantitative
easing (QE) on Thursday, a move which lifted the dark clouds that have recently
hung over financial markets.
In March the ECB will begin purchasing 60 billion euros’ worth of
government and corporate bonds through September 2016. In response
to the announcement the equity markets of several major countries rallied while
the price of gold and silver also rose.
Gold also received a boost after the Danish central bank reduced
its key interest rate for a second time this week, underscoring the concerted
nature of the monetary policy response. Central banks the world over
are finally waking up to the threat of deflation and have responded in lock
step this week. On Wednesday, the Bank of Japan lowered its
inflation outlook to 1% from 1.7%, which boosted the yen. Meanwhile the
Bank of England held off on a previously announced intention to increase
interest rates, which resulted in a 1.63% rally in the FTSE stock
index.
The great danger facing the global economy in recent months has
been the threat of deflation. The U.S. has been the lone standout as
its economy has proven resilient and has been largely immune to deflationary
pressures (with the gasoline price being a conspicuous
exception). The great debate raging among economists has been
whether and for how much longer the U.S. can hold out against the global
economic slowdown. That question may now be moot thanks to the
latest European central bank announcements. Indeed, equity markets
have discounted this and investors are clearly eager to embrace loose
money.
Yet investors haven’t completely cast off their fears as evidenced
by Thursday’s rally in the U.S. dollar index to yet another multi-year
high. By contrast, oil, copper and other economically-sensitive
commodities were down on Thursday despite the ECB announcement. Could
it be that investors aren’t quite ready to believe the seriousness of central
banks’ commitment to monetary stimulus?
Investors certainly can’t be blamed for being skeptical given how
long it took European banks to respond to the deflationary
threat. Foot-dragging is a universal policy among central banks, even when
faced with a major economic crisis (witness the slowness of the Federal
Reserve’s response to the 2007-2008 credit crisis). When central
bankers finally decide to act, however, the policy response tends to be both
emphatic and sustained and nearly always has the desired effect of countering
deflation.
Critics maintain that QE “doesn’t work” but there’s no denying the
efficacy of the Fed’s QE program in staving off deflationary pressures in the
wake of the 2008 credit collapse. Without it the U.S. almost
certainly would have suffered another Great Depression. Indeed, the
one ingredient missing that has prevented a re-inflation of global economies in
the wake of 60-year cycle bottom last October has been the austerity (or
semi-austerity) policies in many European and Asian countries. But
now that policy makers are finally realizing the folly of such policies,
deflation’s days are numbered in the euro zone. Other countries may soon
follow the ECB’s lead, thus fostering the re-inflation of the global
economy.
Now that the promise of coordinated global monetary stimulus may
soon become a reality, what are the intermediate-term implications for gold and
silver? The precious metals should continue to benefit from the
uncertainty that still surrounds the global economic
outlook. Investors aren’t likely to shake off their fears of
deflation overnight and as long as even the slightest apprehension remains,
gold is likely to benefit. But what happens when the promise of
global QE becomes an established reality? At that point there may be
an adjustment phase where gold and silver prices enter lateral trading
ranges. In the overall scheme of things, though, gold and silver
will likely benefit in the early stages of QE.
The U.S. experience with QE from 2009 through 2014 teaches that
the precious metals benefit from the first few years of QE. The
reason is because it usually takes investor psychology a good three years to
adjust to the reversal of a major economic or financial market
trend. Gold’s price rallied from late 2008 through the summer of
2011 before entering a bear market. That’s pretty close to the
traditional 3-year period of psychological adjustment.
If the U.S. QE experience teaches us any lesson it’s that a
pan-European and pan-Asian QE should have a similar impact on investor
psychology. The foreign investors who have incessantly worried about
the impact of deflation will likely take a while to completely shake off these
fears. It certainly won’t happen overnight. As long as
even the vestige of fear persists, gold can benefit from it.
