The decision by European central banks to expand their “financial easing” programmes could provide good support for gold and silver prices in the foreseeable future. After the Bank of England (BoE) announced a further £75 billion of quantiative easing last Thursday (to bring its QE total to £275 billion), the European Central Bank (ECB) announced a plan to provide unlimited liquidity in the form of loans with a one-year maturity. This is designed to prevent a new liquidity crisis in interbank and credit markets, which would lead to another recession affecting economies all over the world.
Analysts at Goldman Sachs said in the past week that precious metal prices are likely to correlate strongly with record-low interest rates in western industrialised countries after their sharp price correction. The rally in gold prices is in their view primarily fueled by low interest rates worldwide. This dynamic remains unchanged, despite the recent selloff in the precious metals sector. Given all the problems afflicting the eurozone, many market participants are convinced that the ECB will lower its key interest rate for the eurozone by 25 basis points (0.25%) when its Council members next convene. ECB President Jean-Claude Trichet said last Thursday that commercial banks in the eurozone could expect generous liquidity injections by the ECB. To achieve this goal, the ECB restarted its tender procedure, which will provide regional commercial banks with unlimited loan facilities for refinancing purposes with a maturity of one year in October and December.
Goldman also point to the significance of the current interest rate environment in the United States in encouraging gold buying. The US Federal Reserve kept its key interest rate constant at 0% to 0.25% over the last three years, but record-low interest rates have not led to a sustained revival of economic activity in the United States. Rising inflation has instead resulted in negative real interest rates in recent months, with investors on financial markets and small savers fleeing into gold and silver for investment purposes. This trend will likely continue, since central banks like the Fed, the BoE and the ECB are trying to devalue the currencies they issue in order to promote exports and lessen the real value of existing debt.
However, there is barely any alternative to the adoption of more QE measures by central banks, assuming that the goal is to prevent the existing global financial system from collapsing. The continued monetisation of outstanding debt in both private and public sectors is leading to turbulence at the currency markets. After the BoE´s announcement last week of more QE, sterling immediately came under strong selling pressure and fell by almost 1% against the US dollar. Owing to this instability and other reasons, Goldman Sachs expects the gold price to start moving higher again. The Fed will most likely not continue to watch current events from the sidelines, as the US economy remains weak. Investors should thus – in addition to Operation Twist – be prepared for the Fed to adopt additional liquidity measures.
Goldman´s gold price target is at $1,860 per troy ounce for the next 12 months (a very conservative estimate given the factors it outlines as favourable to gold). The bank advises its customers to use the correction to build up long positions in the yellow metal.