“We will see if this is the case but we note that investor sentiment towards gold, in the developed western economies, is low.  In the past this has been a useful buy signal.  The current poor sentiment probably reflects the recent trading history of the gold price which has been in a range between $1,550 and $1,800 per ounce. 

We tend think that the world’s monetary authorities will continue with their grand monetary experiment and as a consequence retain our constructive outlook for gold and recommend that all long term investment portfolios should have an allocation to gold and gold equities.


To the extent that the gold price reflects money creation, it is unsurprising that its price performance, although positive, was muted in 2012.  After all the total assets of the Federal Reserve (Fed) barely changed during the year.  This was a surprise to many, including us, who had expected the Fed to continue to add assets to its balance sheet.  Actually from about $2.92 trillion at the start of 2012 its assets fell to a low of $ 2.80 trillion by the end of September.

Since then they have climbed back to $ 2.92 trillion by early January 2013 to show a 0.6% rise for the year.  We expect this to change in 2013.  In September 2012, the Fed announced their intention to purchase $40 billion of mortgage securities each month for an unlimited length of time. 

Further, in December 2012, the Fed announced that they would purchase $ 45 billion of longer dated treasury securities per month.  Added together this amounts to about one trillion dollars over a twelve month period.  This is a huge number and bear in mind that as recently as 2007 the Fed’s balance sheet averaged about $850 billion.  And they may do more.


The  Fed, in the statement  following their December meeting, provided the market with some hints as to what circumstances would cause them to change policy.  The committee said that exceptionally low interest rates would prevail at least as long the unemployment rate remains above 6.5% and inflation is projected to be no more than half a percent above their two per cent target. 

Although the U.S. economy is expanding, growth remains modest.  Higher taxes will likely dampen the positive effect of an improving housing market resulting in sluggish growth in 2013.  Fed policy is likely to remain ultra loose for quite some time even if growth does accelerate as higher interest rates will add mightily to the Government’s interest expense and therefore to the budget deficit.


One of the major events of the fourth quarter was the resounding election victory of the Liberal Democratic Party in the Japanese lower house election held on December 12th.  This resulted in Mr. Abe becoming Prime Minister on December 26th, a position he last held in 2005.  The importance of this election is that Mr. Abe and Mr. Aso, his Finance Minister who is also a former Prime Minister, appear determined to end deflation which has plagued the Japanese economy for decades and spur growth.

The most effective way to create inflation is to weaken the yen.  Despite zero interest rates, a sluggish economy and massive government debt of more than 220% of GDP the yen has been the world’s strongest currency.  This is deflationary.  Thus far Mr. Abe’s verbal assault on the Bank of Japan (BOJ) has resulted in the yen weakening from about 79 to the dollar  in mid-November  to over 90.  This is a significant move in a short period of time.... 

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“The BOJ has not yet taken any serious to cheapen the currency but it seems Mr. Abe means business. He will soon appoint Mr. Shirakawa’s replacement as head of the BOJ.  This handover will take place in April.  Mr. Abe has even threatened to repeal the BOJ law thus reducing the central bank’s independence.


So what could they do differently?  One answer is to copy Switzerland.  Switzerland, tired  of an ever stronger currency, decided to peg its currency to the euro and commit to print as many  francs as necessary to maintain  the announced rate.  In this case words were not enough.  The Swiss National Bank (SNB) has had to print francs and accept euros in return which then get invested in various government bond markets.  The result: an explosion in the size of the SNB’s balance sheet to about $550 billion which is almost the size of the Swiss economy. 

Viewed from a different angle, newly minted Swiss francs have ended up helping finance the deficits of various governments, mostly in the eurozone.  This is creating some price distortions on a fairly minor level but should Japan embark on a similar strategy it would likely be on a much larger scale.  This would probably create further price distortions in sovereign debt and currency markets.


Similar to Japan and the resulting movement in the yen, words have had a major impact on the sovereign debt debacle within the eurozone.  In July, Mario Monti, President of the European Central bank (ECB) said that he would do whatever is necessary to save the euro and then added  the unscripted words; believe me it will be enough. 

Well, those words were enough for government bond spreads within the eurozone to narrow sharply and for the ECB’s newly created bond buying facility, called Outright Monetary Transactions (OMT) to remain in the garage.  Some European leaders are claiming victory but this may be premature as more write-downs can be expected. 

With Europe in recession and with unemployment near 12%, there could be unexpected political upheavals in some countries.  Youth unemployment in Greece is almost 60% which is shocking.  Don’t be surprised if the ECB’s OMT facility gets used in 2013 which will then likely result in the ECB’s balance sheet expanding from its year end level of about $4.0 trillion.   We note that its balance sheet has not changed since March 2012.


There are many other factors, aside from central bank money creation, that can influence the gold price.  Overall investor confidence in economic and monetary management probably ranks high on the list.  We tend to believe that central banks in the western developed countries, by increasingly targeting nominal GDP growth, buying assets and maintaining negative real interest rates, will cause further erosion in investor confidence. 

Indeed, as most countries want to weaken their currencies we believe that gold will continue to attract attention from both private investors and central banks seeking safety.  As central banks are increasingly perceived as involving themselves in fiscal matters such as financing deficits, they face the possibility of losing some of their independence.  This particularly applies to the  BOJ.  Should  this occurs gold will surely benefit.


Most leading central banks, at the margin, continue to shift their emphasis from their traditional role of fighting inflation to fostering economic growth.  This is evidenced by the Fed referring to a target for the rate of unemployment, the BOJ raising its inflation target or even the newly appointed Governor of the Bank of England talking about nominal GDP targeting. 

So in an environment of sluggish economic growth and high debt levels we believe monetary policy will remain highly accommodative.  The assets of the central banks will likely start to expand after a quiet period and the gold price will probably take notice of this and begin a fresh upward move.  The bottom line is we expect new highs in the gold price, and with gold equity valuations and sentiment at such depressed levels, the move by gold stocks to the upside could be very substantial.”

Caesar Bryan

Gabelli & Company

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