As central banks debase currencies, rally in gold prices is inevitable By CHIRAG MEHTA, QUANTUM MUTUAL FUND Gold prices continued moving even higher to reach a six-month high, thus ending the quarter with gains of 10.9%. Markets were increasingly building expectations of further unconventional easing measures and were rewarded to the fullest. Gold surged after a number of actions by Central Banks around the world, who is trying very hard to stimulate their respective economies. The actions, usually centered on money printing, once again had investors looking to gold. The major Central Banks across the globe took action recently; including the Bank of Japan which launched a fresh round of monetary stimulus. The main action though was centered in Europe and the United States. The European Central Bank has promised to buy an unlimited quantity of euro bonds going forward. And the US Federal Reserve announced its third round of monetary stimulus, QE3, which promises to buy $40 billion of mortgage-backed securities monthly on top of its ongoing Operation Twist Programme of buying long-dated Treasuries. The US Fed chief has embarked on this program of unlimited buying of mortgage-backed securities (MBS) in an effort to boost the US economy and to bring down the current high levels of unemployment. According the US Fed chairman, the plan will help to increase prices of homes and reduce unemployment. Ultimately, the Fed hopes to stimulate growth by making consumers “feel” wealthier. A perceived increase in an individual’s wealth will not induce the required spending needed to boost the economy. Since 2009, the Fed has already bought more than $1 trillion worth of MBS since 2009, to no avail. Housing prices remain stagnant and unemployment remains above 8% (as it has been for almost four years). It’s barking against the wrong tree. There is an excess in the housing sector and still the resources are diverted towards the same – a sheer mis-utilisation of scarce resource. But, this is not the only problem the US is facing. It has an unsustainable debt and no effective plan to cut its government budget deficit. Bernanke said the US Fed will continue with the stimulus even after it sees unemployment falling, saying, “We're not going to rush to begin to tighten policy. We're going to give it some time to make sure the recovery is well established." That’s the major risk of such an easing policy. One of the consequences of this monetary policy is that as huge amounts of liquidity is injected into the financial system by the central banks and the value of the money will decrease substantially and higher inflation will become a reality. This is because the central banks have usually not been able to withdraw the monetary excess on time resulting into dire inflationary consequences. Fundamentals: Fiscal evidence suggests a strong pick up in gold demand in India. There’s been some change in sentiment after prices started to move in the right direction again. The recent appreciation in the rupee is leading to some correction in the domestic gold price prompting pre-ponement of purchases. Gold traders are seen increasing their wagers on expectations of rising prices. Investors boosted their bullion holdings to a record on concern that economic growth is slowing and the resultant policy action to such economic woes. Gold bought through exchange-traded products backed by the metal continues to expand marking fresh record levels. Investors are still holding a near-record amount in gold-backed exchange-traded products and central banks are expected to continue their diversification spree. The continuing economic problems around the world and the policy making solutions unveiled have started persuading investors back into gold. With a seasonal likelihood of stronger demand in India and then in China, the second half is likely to be stronger than the first half for the gold market. Outlook: As global Central Banks continue to debase their respective currencies, the inevitable consequence will be higher prices of gold. The higher gold prices are merely reflecting the diminishing purchasing power of the global fiat currencies. There is too much uncertainty in the global arena which is keeping gold well bid. The euro zone has been quiet of late, but that doesn’t mean the problems have disappeared. For instance, bank stress tests in Spain showed that the country's 14 largest lenders will need 60 billion euros in new capital. The peripherals are still in big trouble with the problems being papered over to buy time. The fundamental issues are far from over and will slowly rise to the fore. Despite the opposition and with no economic compulsion to undertake further quantitative easing; still the Fed chief has gone ahead with one. This really reiterates policy mindset which is biased towards such unconventional measures and more accommodative approach. It’s not only the dollar but everyone is in the race to the bottom in a bid to solve the economic problems. In the light of these macro events, gold appears to remain favourable, as an effective portfolio diversifier.