MONETARY expansion has inadvertently given commodity prices a huge boost – but should traders focus on the spot commodity or gold mining equities?
With the creation of QE Infinity – the open-ended quantitative easing programme unveiled last month by the US Federal Reserve – traditional monetary policy is now nothing but a speck on the economy’s rear-view mirror. Who can remember the last time that a Bank of England rate decision made the news? And with this post-2008 loose monetary policy, commodity prices have surged and surged, as market uncertainty drives investors into the perceived safety of gold and other precious metals. At the same time, the Federal Reserve’s massive expansion of its balance sheet has knocked the US currency, giving dollar denominated commodities a boost.
But the open-ended nature of Fed chairman Ben Bernanke’s plan to buy $40bn (£25bn) of agency mortgage-backed securities and also to continue extremely low rates policy until at least mid-2015 has caused issues for gold bulls with markets pricing in the policy. Compare and contrast the atmosphere surrounding today’s Fed meeting with those of the last six months. With the cat out of the bag, there is very little for the Fed to add to its current policy
Compared to the almost unfettered gold bull run of the first half of 2011, the metal has traded in a more restrained range this year. Since the September announcement of QE Infinity, gold has twice tested and failed to break through the psychological $1,800/oz level. Since then, gold has been in a bearish trend, with potential for the price to revisit its 200-day moving average at $1,663.25 if current weakness continues. But that does not mean that gold will not resume its two-year bullish trend.
In the long term it can be argued that gold is a buy. The European debt crisis has not gone away, and is unlikely to do so any time soon. Should we see credit deflation, as a majority of European governments struggle to repay debts, this stress will be passed on to the banking sector. In this event, investors will be drawn to liquid and unleveraged assets. Gold has taken this role in the past, and there is no reason why it will not do so going forward.
But there are still people out there who have a philosophical opposition to gold. As Warren Buffet has said: “You can’t eat gold.” You can’t eat share certificates either, but stocks do yield dividends, something that will attract traditional investors. And though they do not grab the headlines quite like predictions of a $2,000 gold price, there is a strong case to be made for gold mining equities.
It is important to note that a strong market for spot commodities or futures, does not always mean a bull market for equities. They do not have the same liquidity as the commodity that they are digging out of the ground, and they are subject to microeconomic factors that spot commodity traders can largely ignore. But producers who have gold in the ground that is uneconomical to mine at $1,000/oz can find it economical to do so at $1,800 – making these mining equities a strong buy. And those who know their way around a balance sheet can pick out bargains.
However, traders should note that commodity-linked stocks are equities and not commodities, meaning that they can experience the volatility that commodities often avoid.
Despite a setback, profits are out there to be had in both commodities and mining equities. But stock pickers should tread carefully – not all that glitters is gold.