Gold shines even brighter in times of monetary stimulus

Since virtually all of the world’s primary monetary policymakers are engaged in similar action, currencies should depreciate against the only credible alternative – gold

IT IS more than one month since Mario Draghi, the European Central Bank president, revealed the monetary policymaker’s latest “shock-and-awe” response to the seemingly interminable euro zone debt crisis. Frankfurt’s latest manoeuvre was quickly followed by news from Beijing that the National Development and Reform Commission had approved 60 new projects, centred on roads and infrastructure projects, totalling more than $150 billion.

The flood of stimulus measures, designed to boost flagging global economic growth, did not end there. One week later, Ben Bernanke, chairman of the Federal Reserve Board, declared that he would do whatever proved necessary to jump-start the US economy. His words were accompanied by the third round of quantitative easing, which, unlike previous programmes, is limited neither in duration nor magnitude.

Not to be left out, the Bank of Japan joined the stimulus offensive within a matter of days, announcing an unconventional monetary programme of its own. Although the latest central bank action is capped at a relatively paltry $126 billion, the monetary policymaker hinted that it would engage in further monetary stimulus, and consider other unconventional policy initiatives, if the latest measures did not fulfil objectives.

Investors greeted the bold central bank efforts to thwart an even deeper global slowdown than is already plain to see with all-too-predictable enthusiasm. But the initial euphoria has faded, as market participants come to terms with the fact that monetary policy is relatively impotent in the face of strong structural headwinds that include the demise of the debt-driven economic model across the Western world, alongside a much-needed rethink of the investment-driven model that has underpinned economic growth in China.

As stock prices struggle to add to their impressive summer gains, gold has awoken from a slumber of several months. Its recent upward move has brought year-to-date gains close to 17 per cent, and the price of the precious metal is now within 6 per cent of the record high set during last autumn.

Could policymakers’ latest efforts to return the global economy to a more familiar growth trajectory signal the beginning of the latest phase in gold’s bull market, now lasting over a decade?

The latest stimulus measures, and the accompanying expansion of the monetary base, may do little but prevent growth from falling too far below potential in the respective economic jurisdictions and thus have no discernible impact on inflationary pressures. However, investors should recognise that the need for continued near-zero interest rates across most of the advanced world, not to mention round after round of unconventional monetary operations simply to keep unstable dynamics from taking hold, is uniformly positive for gold.