Bernanke lights a fire under gold and silver prices

2012-JAN-26

“Party on!” was Federal Reserve Chairman Ben Bernanke’s message to Wall Street yesterday, as he announced that the Fed will be keeping interest rates at “exceptionally low” levels until late 2014, owing to concerns about stubbornly-high unemployment and the sustainability of the current statistical recovery. Bernanke also confirmed that for the first time in the Fed’s 99-year history, the institution will explicitly target a 2% inflation rate, as measured on the Personal Consumption Index (PCI). Other central banks have long had explicit inflation targets, but not the Fed.

Unsurprisingly given their enthusiasm for easy money, the market response to this move was euphoric. The Dow gained 0.64% to settle at 12756.96, while the Nasdaq tacked on 1.14% to settle at 2818.31. Asian and European exchanges have also reported gains this morning. Commodities such as copper and crude oil are up, while precious metals – ever sensitive to signs of more monetary easing from the Fed – notched impressive gains.

The gold price blew through overhead resistance around $1,680 with ease, and is now trading back above $1,700 per troy ounce. Silver broke through the $33 mark easily, which could be technically significant given that the price has been encountering stubborn selling around $32.50-$33 since last autumn. If silver can break through $35, and if we see signs that hedge funds are at last beginning to grasp that both the Fed and the European Central Bank are committed to more-or-less perpetual money printing – whatever euphemisms they may use to disguise this fact – silver has a real chance of starting the kind of trending move higher that we saw in late 2010/early 2011.

The flip side of this particular coin is of course renewed weakness in the US dollar. Significant risk rallies since the crisis of late 2008 have always been accompanied by a falling Dollar Index, and yesterday was no exception – the USDX falling below 80. As of 10.20GMT, it's down at 79.21. Looks like we could be at the start of another one of those periods when the markets forget all that’s wrong with the world and bid up just about everything except the greenback and US Treasuries.

If the USDX continues falling towards its all-time low around 72, expect further gains in gold and silver prices, and expect silver to outperform gold as US inflation expectations rise. This will make a formal announcement of “QE3” from the Fed or nominal GDP targeting less likely in the short run, as the falling dollar and rising prices in America obviate the short-term need for more aggressive Fed action. That is until we get the next bearish downturn accompanied by falling stock markets, commodities, and a rising dollar, when the Fed will again engage in more efforts to weaken the dollar against other currencies in order to gain export advantage for the US economy.

“Rinse, lather and repeat” as they say. The Sean Corrigan article we linked to yesterday explains the cyclical nature of our current downturn very well. Of course, central banks can devalue their own currencies, but they cannot devalue precious metals.