Analysis: Fed easing burnishes already lustrous gold

By Jan Harvey

LONDON (BestGrowthStock) – The Federal Reserve’s $600 billion quantitative easing package has reinforced the medium-term argument for holding gold, as it pushes the dollar firmly onto a downward path and raises the risk of inflation.

In a hotly anticipated statement late on Wednesday, the Fed said it would buy $75 billion in longer-term Treasury bonds a month through the end of June 2011, and could adjust purchases depending on the strength of the recovery.

The statement broadly met expectations and has led to steady gains in gold, chiefly on the back of a slide in the dollar to 11-month lows against a currency basket.

Longer term, it is set to further underpin the precious metal’s rally to record highs.

“This is going to play out bullishly for the precious metals,” said Credit Suisse analyst Tom Kendall, pointing to renewed weakness in the dollar after the statement.

“The announcement itself was broadly in line with market consensus, but it still leaves an air of uncertainty in terms of the fact that the Fed will review the scale and timing of this additional QE. That leaves the potential for further surprises as we go forwards.”

Gold’s initial reaction to the news was largely driven by the dollar. The two typically have a close inverse relationship, as gold can be bought as an alternative to the U.S. unit, and becomes cheaper for other currency holders as the dollar slips.

CORRELATION IN FOCUS

While this correlation erodes at times of extreme uncertainty in the financial markets — as seen earlier this year as the euro zone sovereign debt crisis bit — the link has recently strengthened.

The U.S. currency fell sharply after the Fed statement, hitting a 28-year low against the flourishing Australian dollar and sliding against the euro, sterling and yen.

The possibility of further adjustments to the level of QE could inject even more volatility into the dollar, with Commerzbank saying in a note that the policy could prove a “bottomless pit.”

“Things are likely to become increasingly uncomfortable for the U.S. dollar, and it only seems a matter of time until EUR-USD breaches its recent high at 1.4160,” it said.

The QE measures will also underline current tensions in the currency markets. Policymakers in key emerging markets, including BRIC powerhouses China and Brazil, have already pledged to implement fresh measures to curb capital inflows in response to the Fed.

The dissatisfaction they have voiced in response to the fresh round of easing is likely to make a deal on global imbalances and currencies at the next Group of 20 meeting in Seoul even less likely.

“Gold is not a paper currency, it is nobody else’s liability, it is not a promise to pay by a bank and it’s something you can’t print, whereas dollar bills and other paper currencies you just turn the printing press on,” said Evy Hambro, manager of BlackRock’s (BLK.N: ) Gold & General Fund.

“What we’re seeing now is a general shift in people’s attitude toward things that are going to preserve their purchasing power over time and gold is a natural beneficiary of this kind of activity in the market.”

EXPECTATIONS FOR INFLATION

Meanwhile, the long end of the U.S. Treasury yield curve steepened on Thursday and the five-year/30-year rate spread widened to record levels as investors bet that a fresh round of quantitative easing by the Fed would stoke future inflation.

Looking forward, this may also be good news for gold, which is often seen as a hedge against inflation.

“Obviously (the Fed) don’t see inflation as being an issue in the near term, and if anything they want to bring inflation up to a certain level,” said Saxo Bank senior manager Ole Hansen. “So on that basis, hold onto your gold.”

Analysts expect currency tensions, coupled with a host of other positive factors such as official sector buying, to lift prices to fresh record highs this year and next. (PREC/POLL: )

“Over the medium term in a QE environment, we remain bullish on gold, with inflation expectations on the rise, low real interest rates, the fear of currency debasement,” said UBS analyst Edel Tully, who maintains a one-month price target of $1,425 an ounce.

Aside from monetary policy, she said resilient physical demand and limited scrap sales, central banks acting as net buyers and a desire for safe-haven assets provided further good reasons for holding gold.

(Additional reporting by Amanda Cooper; editing by Sue Thomas)

Analysis: Fed easing burnishes already lustrous gold