Gold and Gold Stocks 2009 Boost from Central Bank Quantitative Easing Measures

By: Christopher_Laird

The US Fed just cut its Fed Funds target to 0 to .25% and is also likely to use other means to lower interest rates in the US such as buying long term US Treasuries and other bonds directly. The rationale is that merely lowering the Fed Funds rates is not finding its way into credit markets because lenders still don't want to lend.

Money sitting in short term bonds, but long term bonds set mortgage rates

We know that shorter term US Treasuries are yielding practically zero rates, or zero to two percent for terms longer than 4 weeks. People want to be in cash, and they are flooding into US Treasuries because they don't trust banks, even with FDIC guarantees. And, this is one reason the USD rose so much in recent months with the latest detonation of the world credit markets after Lehman failed, etc.

Long term rates are much less affected by a low Fed Funds rate, so as an alternative, the US Fed can buy longer term US Treasuries such as the 10 year, which is what sets mortgage rates generally. That is called a quantitative easing strategy.

In any case, for the US Fed to buy US Treasury bonds directly is called quantitative easing (one strategy to do it). This forces interest rates down across the board, and interferes with the normal bond market setting interest rates. It is a radical step to take, and is looked at as monetization of US Debt. It is also a very dangerous new step to take because the USD is already taxed by all these $8 trillion plus bailouts in a mere year and a half since August 07.

Other central banks will have to follow Fed

Now, with the US using a virtually zero Fed Funds rate and using quantitative easing, the other central banks will be forced to follow along. Low interest rates are gold friendly (bonds compete for flight to safety money by offering interest while gold does not).

Also, quantitative easing is very very gold bullish. When the Fed, which controls the US money supply, buys US Treasury bonds directly, that may force long term rates down, but will be looked at by the usual buyers and holders of US treasuries as using a printing press to finance the US government.  It also makes holding the Treasuries less desirable because of the lower interest yield. So, quantitative easing hits the credibility of the US dollar, and US Treasuries, in two big ways.

Other Central banks going to use quantitative easing too?

Now, it would be one thing if the US alone was going to do quantitative easing. It's quite another thing if other major central banks get involved too. If they also start buying their own bonds, then their haven aspect compared to the USD is also called into question. That is super gold bullish if the others follow.

“Dec. 17 (Bloomberg) -- The Bank of Japan may this week follow the Federal Reserve deeper into the zero interest-rate world, beating European counterparts to the punch and forcing it to mull unorthodox methods to revive its economy.

Investors see a 54 percent chance that the Bank of Japan's policy board will reduce its overnight call rate from 0.3 percent at this week's meeting after the Fed yesterday pared its key rate to as low as zero. That would leave it to pursue unconventional ways to boost economic growth such as by buying corporate bonds to reduce market borrowing rates.

“The Bank of Japan will want, and has to be seen, to match the Fed in its response to the sharp economic slowdown,” said Julian Jessop , chief international economist at Capital Economics Ltd. in London.

The use of so-called quantitative measures to lower borrowing costs in the U.S. and Japan may emerge as a global theme in 2009 should the recession and the ongoing credit crunch oblige central banks in Europe to cut interest rates.

“Central banks everywhere are going to be pushing rates closer to zero and thinking of new ways to kick start their economies,” said David Owen , chief economist at Dresdner Kleinwort in London. “The financial crisis is still going and recessions are getting worse.”
Bloomberg.com

That article also states the BOE and Swiss National Bank are considering/discussing quantitative easing. The ECB is resisting further cuts and not commenting so far on quantitative easing measures. One problem for the ECB in using quantitative easing is they have many nations to deal with, and which country's bonds would they buy anyway? That would certainly lead to a big battle between Germany and whoever else. Germany already does not like the ECB bailouts as it is (ECB bailouts are another $5 trillion according to my estimates).

But, putting the ECB aside, the point is that other major central banks are moving toward quantitative easing, not the US Fed alone. Again, this is one of the most gold bullish developments since the Credit Crisis began a year and a half ago.

Competitive currency devaluations

And so, the next item on the agenda? Competitive currency devaluations. First, if central banks are going to do quantitative easing and competing interest rate cuts, that causes their currency to devalue. If the US, the world consumer behemoth starts quantitative easing, then everyone will compete and devalue their currencies, and don't forget China here either. They are extremely susceptible to a big economic downturn. We did a special report on China this week in the subscriber newsletter.

So, if there is going to be competitive currency devaluation, again, that is gold friendly to the maximum.

Gold and gold stocks should do well in 09

I think we can say that gold and gold stocks are sure to do well in 2009 forward. Of course, there will be intervening periods of USD strength, and gold volatility, but all that means is that there is world currency instability, which is ultimately going to drive gold and precious metals to new highs not seen before. In the mean time, confusing volatility goes for currencies and precious metals.

We are closely tracking the currency situation for subscribers (including gold), and about a month ago, called a possible gold bottom. The USD is still due for bouts of strength (more than it might be due for considering all this monetary easing) till the end of the year though. After December, we expect the USD to turn down significantly.

By Christopher Laird
PrudentSquirrel.com

Copyright © 2008 Christopher Laird

Chris Laird has been an Oracle systems engineer, database administrator, and math teacher. He has a BS in mathematics from UCLA and is a certified Oracle database administrator. He has been an avid follower of financial news since childhood. His father is Jere Laird, former business editor of KNX news AM 1070, Los Angeles (ret). He has grown up immersed in financial news. His Grandmother was Alice Widener, publisher of USA magazine in the 60's to 80's, a newsletter that covered many of the topics you find today at the preeminent gold sites. Chris is the publisher of the Prudent Squirrel newsletter, an economic and gold commentary.

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