3 Experts On Gold And The Effect Of QE Tapering

The severe drop in commodities and equity markets that followed the US Federal Reserve’s indication that it could soon “taper” quantitative easing (QE) had Gold Investing News (GIN) wondering what would happen to gold if QE actually came to an end.

GIN solicited the opinions of three experts: Frank Holmes, CEO of US Global Investors; Julian Phillips, analyst at The Gold Forecaster; and Peter Schiff, CEO of Euro Pacific Capital.

GIN: If the US Federal Reserve does go ahead with tapering QE as it suggested it would last week, what would be the impact on the gold price?

Frank Holmes: I think the news should be good for gold investors. Not only is the Fed maintaining its course, the world is also continuing its synchronized easing. With this global easing cycle, gold and equities had been moving together, but have been taking vastly diverging paths in the past six months. In fact, according to UBS Investment Research, the gold-to-S&P 500 (INDEXSP:.INX) ratio has fallen to lows not seen since 2008. As I often remind investors, gold buyers are a diverse group, but generally fall into one of two categories. Most of the attention gets focused on those who purchase out of fear of damaging government policies (i.e., the fear trade).

I think gold can easily bounce here. The ratio, I would say, 10 percent on the downside, 30 percent on the upside over the next 18 months.

Julian Phillips: While the Fed has made plans for such tapering, markets are discounting this already and reading that it is deflationary.

Consequently, the Fed’s planned impact will not happen. Instead, they may find that they have to counter the bond markets sell-off with a statement that calms the market so it then has to wait for the Fed’s action.

Unfortunately, what we have been forecasting for more than a year now is happening: financial markets across the world are turning mercurial.

The Fed has had to endure the handicap of almost zero government support for growth, something that has undermined its efforts and will continue to do so. This won’t change until an election that brings in one or the other party with a clear program of economic growth, but as the Bank for International Settlements is now warning, “is growth enough?” In the Eurozone it is the structure that is conspiring against an economic recovery.

It’s important to bear in mind that since the credit crunch in 2007, we have been hearing of the “coming recovery.” Mr. Bernanke has reassured the world that growth is now visible enough to contemplate tapering off QE, hoping markets would take this as positive news. But instead they have focused on the accompanying rise in interest rates that must happen. With markets discounting these rises, they are precipitating them at prices that undermine growth. The US economy remains fragile and the rest of the developed world in recession. Rises in interest rates will now savage growth.

This becomes a deflationary environment, while money supply continues to expand tremendously. Combine the two and you have unstable markets.

We look at the gold price in 2007, when it fell from its then peak of $1,200 to below $1,000 before the uncertain and unstable developed world’s economies caused it to turn around and resume the rise to over $1,900. We are entering not just a repeat of that time, but one where past efforts have failed. Now we have confirmation that governments and central banks have failed to rectify matters and remain faced with the same, but worse problems. We expect that once the current falls have been completed, a turnaround will begin to take gold and silver prices higher and considerably past previous peaks. The current fall is now not supported by large volumes of sales, simply the holding back by buyers. When prices do turn, we see them turning quickly and moving higher on lower volumes.

Please note that the fundamentals on the monetary front have never described such a positive picture for gold since 1971. I do not believe that gold will stay down at these levels for long.

The monetary problems that have brewed so far to date tell me that gold is not down and out by a long way.

Peter Schiff (excerpt from his June 21 commentary Tapering the Taper Talk): It’s fascinating how the goal posts have moved quickly on the Fed’s playing field. Months ago the conversation focused on the “exit strategy” it would use to unwind the trillions in bonds and mortgages that it had accumulated over the last few years. Despite apparent improvements in the economy, those discussions have given way to the more modest expectations for the “tapering” of QE. I believe that we should really be expecting a “tapering” of the tapering conversations.

As a result, I expect that the Fed will continue to pantomime that an eventual exit strategy is preparing for a grand entrance, even as their timeline and decision criteria become ever more ambiguous. In truth, I believe that the Fed’s next big announcement will be to increase, not diminish QE. After all, Bernanke made clear in his press conference that if the economy does not perform up to his expectations, he will simply do more of what has already failed.

Of course, when the Fed is forced to make this concession, it should be obvious to a critical mass that the recovery is a sham. Investors will realize that years of QE have only exacerbated the problems it was meant to solve. When the grim reality of QE infinity sets in, the dollar will drop, gold will climb, and the real crash will finally be upon us. Buckle up.

GIN: In this new gold price reality (under $1,300) do you see more negative fallout from the major gold miners in terms of project cancellations/ deferments/lower production? Which major gold companies are best able to weather the storm?

Frank Holmes: Mining companies have stopped making dumb acquisitions, are increasing their dividends and one company is buying back their stock to improve “shareholder yield,” which is a combination of raising dividends and stock repurchases. Supply is contracting and companies that have their costs under control will perform well. For those reasons, I favor companies such as Alamos Gold (TSX:AGI,NYSE:AGI), Royal Gold (TSX:RGL) and Franco-Nevada (TSX:FNV,NYSE:FNV), which pays monthly dividends.

Julian Phillips: Barrick Gold (TSX:ABX,NYSE:ABX) Newcrest Mining (TSX:NM,ASX:NCM) and Gold Fields (NYSE:GFI) are writing down their assets and financing is drying up at the moment for unfinanced juniors. Supplies of gold come from two main sources, scrap sales at +1,700 tonnes and newly mined gold at +2,800 tonnes. The SPDR gold ETF (ARCA:SPY) has supplied around 500+ tonnes in the last three months and the banks and hedge funds that engineered the “bear raid” on gold around 300+ tonnes in the same period. Only the SPDR fund remains a seller of gold now. Scrap sales have petered out to a trickle while mining companies have had to reduce their gold reserves, heavily cutting out the low-grade reserves as they became unprofitable. It may be that they can maintain production levels at past levels, but their life is now shorter. So from now on we do expect to see newly mined gold production slow.

Combine the fall in scrap, newly mined gold and the large tonnage sold in the US ceasing, and you can see that supplies have fallen in the last month dramatically. The major miners we have mentioned as well as the well-established miners such as Goldcorp (TSX:G,NYSE:GG) will ride out this storm.

GIN: Is there hope for the junior gold mining sector in this new lower gold price environment?

Frank Holmes: I believe three trends will hurt the junior resource cycle for the next few years: 1) A lack of discoveries; 2) geologists having no relationship with money managers or capital markets; and 3) excessive government regulations. But there are mining companies that are adapting to these challenges by focusing on a return-on-capital model or increasing their dividends.

Based on new rules, the regulatory environment is anti-risk taking which will impact the formation of capital and job creation. Further, commodity prices are soft and this impacts investor sentiment, and finally there have been so many delays and disappointments with emerging countries changing the tax laws and environment rules. When we add up all three factors, the juniors will continue to be under pressure unless they have a world class discovery in a safe jurisdiction.

Julian Phillips: Some of the well-financed, capable juniors will recover tremendously. That’s why George Soros bought $225 million in derivatives in them. We see this current gold price (or lower still) as a temporary opportunity.

Taking a longer view from the fourth quarter of this year onwards we see a very different environment for gold and silver than the one we are in now. The government action against gold imports into India is perhaps a greater factor than current US gold sales right now, so we are watching to see how that market is countering these moves to see the shape of their demand going forward. If they do counter their moves we should see demand from Asia jump strongly in that quarter. By that time, US sales of gold should have terminated.