Gold prices have eased back further this week, with a sharp plunge overnight taking the yellow metal down to USD $1219oz, down 1% since last Fridays London PM Fix.

Silver has also weakened, currently sitting at $18.42 an ounce – also down about 1% over the past 4 trading days.

The big news overnight was of course the latest meeting by the Federal Reserve, who, as expected, further reduced the size of their current QE programme, this time to $15bn a month.

Other key comments and takeaways from the meeting were as follows

• They left the Federal funds rate unchanged at 0.25 percent

• They repeated it would be appropriate to maintain “highly accommodative” monetary policy

• They maintained their pledge to keep interest rates low for a “considerable time” even after QE ends

• They plan to end the QE progamme at their next meeting, absent any shocks to the economy or financial markets

• They stated that according to their models, inflation is running below their long term goals

• They stated that they see the US economy expanding, and the labour market improving, but that significant underutilization still exists in labour markets

All in all this was largely as markets expected, with no major surprises thrown in by the Fed, with the bigger news of the night probably the decline in headline US Consumer Price Inflation, which came in at -0.2% for the month.

Originally gold had largely ignored the developments in CPI and the pronouncements from the Fed, trading above USD $1235oz for the majority of the day before plunging some $15oz in fairly quick succession, a move repeated in silver, which gave up $0.30oz in a similar time frame.

All in all, the current weakness in the gold price can be mostly attributed to the strength in the United States Dollar, which has been on an absolute tear of late. Indeed the USD has been in a solid uptrend for the better part of three years now, as the chart below highlights clearly. In that time, the US Dollar index has strengthened from the low 70’s to the mid 80’s, a rally of some 15%.

Not surprisingly, this has coincided with the 3-year correction in the gold price that we have endured. For AUD investors, the correction has been less severe, as the declining AUD (which fell back below USD $0.90 overnight) has helped cushion the blow.

The rationale behind the climb in the USD, especially the sharp rally we’ve seen in the last two months, is the expectation that interest rates in the US are on the way up, with Federal Reserve projections indicating that the federal funds rate could be comfortably in the 3% range by 2017, and continuing to climb.

As the Europeans are embarking on another round of QE, and as the Bank of Japan is likely to increase the monetary dosages it’s giving the moribund Japanese economy, the logic goes that the USD will continue to strengthen.

Frankly, we don’t buy it. Not only is the USD extremely overbought right now, but the simple mathematical truth is that the United States Government, and indeed the US economy can’t afford higher interest rates

For evidence of this, look no further than the chart below, which appeared in the Daily Reckonings overnight. The chart highlights the current 2014 spend by the Federal government on a range of areas, including Federal courts, the Department of Education, National Parks, NASA and the FBI.

It also shows the projected 2024 spend on interest on the national debt based on where the CBO sees interest rates at that time.

As you can see form the above, covering interest will be about 3.5 times more expensive than paying the current costs of all of those other areas indicated combined.

This would require savage spending cuts in other areas, huge tax increases, or some combination of the two.

Make no mistake about it – real interest rates will not be rising in any meaningful way in the coming years, either in the US or around the globe, and this current USD rally will fizzle out and burn.

When the tide turns – the run into gold and silver is going to be incredibly profitable.

Gold and TERRORble Investing

One week ago, the world commemorated the 13th anniversary of the attack on the Twin Towers in New York City. I was asleep when the incident occurred. It was the middle of the night in Sydney, and my first thought, if I’m being honest, was one of anger towards my then flatmate, who’d come home well refreshed after a visit to the pub with his brother, and who woke me up screaming “Planes have hit the World Trade centre”.

Bleary eyed – I got up – watched the news for about half an hour – and then tried to go back to sleep, before giving up and heading into work, which at the time was on level 40 of what is now the Suncorp Building in George Street Sydney.

Bill Bonner, whose famous trade of the last decade was “sell the DOW and buy Gold”, mentioned in a piece he wrote at the time, that history would probably come to judge the attack on the twin towers much the same way as it did the assassination of Archduke Franz Ferdinand, which in many ways paved the way for the onset of World War 1.

Bills piece can be read here for those interested

More than a decade on, and it’s clear that this era of war, terror and conflict is far from over, what with Ukraine still on edge, and Australian and American troops seemingly headed back into Iraq and Syria for what will effectively be Gulf War 3.

As a result, as much as one wishes this catalyst, or rationale for holding gold didn’t exist, it’s hard not to think that gold will reassert its role as a true safe haven asset in the coming years.

Indeed a dispassionate analysis of market movements since this era of elevated geopolitical conflict began highlights pretty clearly why one would want to be bullish gold going forward, unless one thinks peaceful resolutions are soon to be achieved in the middle-east and beyond.

The table below, which goes all the way back to that fateful say of September 11 2001, highlights where key markets were sitting at the time, and on other key dates in the subsequent ten plus years, from the Bali bombing, to the attacks in London, right up until the death of Muammar Gaddafi nearly three years ago.

As you can see, gold prices have more than quadrupled since late 2001, whilst equities, using the S&P500 as a proxy, haven’t even doubled in that time, despite their outperformance over gold since 2011.

Bonds have also rallied in the last decade, though going forward, with yields at multi century lows, and debt levels at unprecedented highs, the risk/reward trade in that asset class is highly questionable at best.

The data is pretty clear – and that is that if the last 13 years has taught us anything, its that, despite the daily volatility – gold does protect investors through the darker times, be they economic or geopolitical.

Sadly, the potential for some kind of major military conflict or flare in the coming years is another reason to be bullish on precious metals, and recognise its importance in a well balanced portfolio, even though this isn’t the primary motivation to invest in the sector.

The bullish case for precious metals is strong enough without this added impetus, and today’s pull back in prices should be seen as a buying opportunity.

Until next week

Disclaimer

This publication is for education purposes only and should not be considered either general of personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, past performance is not necessarily indicative of future performance. Any prices, quotes or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness.