Central bankers make compelling case for long term bulls on gold

While the exchange traded fund for gold (NYSE: GLD) is down almost 8% for the last quarter, the future for The Yellow Metal is shining bright due to the actions of central bankers around the world.

Led by Federal Reserve Chairman Ben Bernanke, global central bankers have embarked on a series of economic stimulus measures featuring the purchase of sovereign debt. Known as “quantitative easing” these central bank actions are a de facto admission that what should be considered the most desirable investment, a government bond, cannot find any buyers at such lower interest rates. If there were interested parties, there would be no need for the quantitative easing measures.

Eventually this will lead to inflation. The US Federal Reserve has about $3 trillion on its balance sheet. These “assets’ are government bonds and mortgage-backed securities that no other investors wanted to buy. If there had been others, there would have been no need for the Federal Reserve to expand its balance sheet to acquire this debt.

Before The Great Recession, the Federal Reserve had about $700 billion in assets.  But to recapitalize the global financial system, the Federal Reserve has acquired trillions in securities that others do not want.  This unprecedented move was due to Congress being unable to appropriate the necessary funds as there was no buyer for the needed bonds to finance it.

The same holds true for the governing bodies of Europe and Japan. The central bank for each has initiated rounds of quantitative easing to stimulate the economies. As Europe is in a recession, Japan now in its 23rd year of the lost decade, and the United States still enduring anemic economic growth, these measures are nowhere near completed.

In a press conference in September, Federal Reserve Chairman Bernanke stated that about $80 billion in Treasury bonds and mortgage-backed securities would be purchased monthly. He also noted that this could continue until late 2015. At roughly $1 trillion a year, that will take the balance sheet of the Federal Reserve over $5 trillion. Eventually, those securities will have to find a new home.

That will require higher interest rates. Gross savings in the United States is around $1 trillion, so there is no way that American consumption can move those assets. As a result, foreign investors will have to be attracted.

This much capital entering the monetary system will inevitably result in global inflation. When that happens, the price of gold will rise. At present, Treasury yields are low  due to the depth of the market.  Investors are investing for liquidity, not yield. That is taking place due to the low interest rate environment around the world orchestrated by Bernanke

As a result, gold has not responded like it did to the previous rounds of quantitative easing.  The GLD is trading below its 20-day, 50-day, and 200-day moving averages.  It reached the bottom Bollinger Band in recent trading after touching the top at the time Bernanke announced Quantitative Easing 3 back in September.  Recent volume has been weak, too, after peaking in early September before QE3 was presented.

Many are expecting gold to fall even more. There is now a short float of 5.18% allayed against the GLD (a short float of 55 is considered to be troubling for a security).  At around $160, the GLD is about 8% below the 52-week high of $174.07, and well above the low of $148.53.

Eventually, market forces will overwhelm even the efforts of global central bankers. When that happens, gold will return again to its role as a safe haven asset. Due to the fundamental forces of supply and demand, The Yellow Metal will reverse its recent decline and surge over the long term.