Don't be duped by the hawkish chatter! The decision taken just a few weeks ago by the Federal Open Market Committee (FOMC) -- to embark upon a fourth round of quantitative easing ("QE") with open-ended asset purchases totaling $85 billion per month -- resulted from a nearly unanimous vote. Richmond Fed President Jeffrey Lacker provided the sole dissenting vote.
Despite the committee's near-consensus stance regarding the need for additional monetary stimulus at this time, gold limped into 2013 with about a $50 decline after the minutes to that December FOMC meeting suggested a growing sense of unease among several committee members with the potential consequences of their policy measures. According to the minutes, several members "thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013, citing concerns about financial stability or the size of the balance sheet".
The fruitless search for practical alternatives
But I feel obliged to share my view that the Fed faces an intractable predicament that will prevent QE4 from representing the final chapter in this historic four-year-old continuum of quantitative easing. With its latest buck-passing maneuver around the fiscal cliff, the U.S. political establishment has evidenced once again an appalling lack of appetite for meaningful budget reform as we continue to dive deeper into a debt crisis of unthinkable dimension. If carried through to the end of 2013, the ongoing QE4 program would extend the Federal Reserve's balance sheet by an amount greater than the entire projected Federal deficit for the period, and absorb roughly 90% of net sales of all new U.S. dollar-denominated fixed-income debt issued during fiscal 2013.
Take that enormous debt sponge away, and you have the makings for an abrupt, disruptive, and potentially calamitous increase in bond yields for longer-dated maturities. In my view, we would not have to wait long before increased borrowing costs would translate into resurgent budget distress through each level of government from the federal level down to struggling municipalities. More acutely, I think we would see those beginning stages of normalization that we've observed recently from the housing market reverse course rather violently.
By far the most potent peril of any hypothetical end to the Fed's QE program, meanwhile, resides in what I believe is the real reason that these measures formed the cornerstone of chairman Bernanke's crisis-response playbook in the first place. The way I see it, the Fed's revised mandate to target specific employment and inflation metrics plays second fiddle to the overriding and largely unspoken goal of forestalling the violent deleveraging of the global derivatives market and the associated systemic risk to the entire financial system. During 2012, all eyes shifted to Europe as the same monster of toxic derivative assets that tore through Lehman and Bear Stearns four years earlier again reared its ugly head. As Tanzanian Royalty Exploration (TRX -2.04%) chairman and noted gold authority Jim Sinclair points out, the prevailing accounting practices that permit financial institutions to assign fanciful mark-to-model valuations to impaired and often worthless derivative paper continues to mask the very real and present danger that these assets will yet spawn another violent deleveraging fiasco. As a result, Sinclair asserts, the Federal Reserve "has no practical option to end QE."
The race to debase, and the Japan syndrome
Those FOMC members who expressed concern over likely consequences of the ongoing QE strategy have every reason to be concerned. Referring to the total combined balance sheet expansions since 2009 by the world's six largest central banks, PIMCO founder Bill Gross recently reminded investors:
"The future price tag of printing six trillion dollars' worth of checks comes in the form of inflation and devaluation of currencies either relative to each other, or to commodities in less limitless supply such as oil or gold."
Simply stated, when the Federal Reserve -- as the issuing central bank of the world's primary reserve currency -- adopts QE as a cornerstone of policy responses to a major debt crisis, the other major central banks are pressured to weaken their respective currencies in kind. I stated more than two years ago that "fiat currencies weak and strong are ultimately embroiled in this race to debase as a consequence of the global financial crisis and the official responses to it." Think of it as a game of hot potato, where the dreaded potato is the currency that appreciates against its rivals and stifles domestic growth in the process. No nation wants its hands burned, and so each successive act of monetary intervention around the globe tosses the potato to the less-impaired currency du jour. Investment banker and risk consultant James Rickards addresses these topics intelligently in his aptly named book, Currency Wars.
It is within that context that I encourage investors to consider the full implications of the "bold monetary easing" campaign that Japan's Prime Minister Shinzo Abe now proposes to pursue. Abe recently declared: "Japan's most pressing task is to free itself from deflation and the strong yen so an economic recovery can occur." David Bloom, currency chief at HSBC, notes that "everybody is trying to weaken their currency at the same time. The Swiss have got away with it, and now the Japanese want to try." Bloom continues: "Policymakers are doing things that if you had suggested four years ago they would have put you in a straitjacket and thrown you in a cell. I don't rule out anything any longer in this market. Desperate times lead to desperate acts." Japan's "desperate acts," in this Fool's firm opinion, are unlikely to yield the escape from the nation's deflationary maelstrom that Abe referenced. What it is likely to ensure, on the other hand, is that Fed chairman Ben Bernanke will feel the monetary hot potato burning his hands unless he keeps a firm grip on his helicopter controls.
So, the next time someone tries to tell you that gold's bull market is drawing to a close because the FOMC minutes suggest to them that the Fed's QE program is approaching its conclusion, let them know that you've weighed all of the evidence at your disposal, and determined that we're far more likely to see additional rounds of global competitive currency devaluation as these debt-derived currency wars play out before our eyes.
And now, my outlook for gold in 2013
Based upon my continuous analysis of gold supply and demand fundamentals, the compelling technical picture as interpreted by legends of their trade like Louise Yamada, and my own assessment of some of the more likely macroeconomic and monetary policy scenarios before us, I am resolute in my expectation of another strong showing for gold during 2013. While this rough start to the year may extend the ongoing correction a bit further in chronological terms, I see gold regaining its footing by about the second quarter, and then securing a meaningful breakout during the second half of the year. Conservatively, I project that 2013 will see the gold price at least knocking on the door of my long-anticipated $2,000 mark, while any number of reasonable scenarios could be seen carrying the monetary metal substantially higher.
That outlook implies at least a 20% advance for gold, but I believe investors could enjoy far superior gains by investing in some of the top-notch gold companies that I've recommended to my readers for 2013. My top pick is Sabina Gold & Silver (SGSVF), which has already advanced 17% in the face of gold's tumble since I published my selections less than two weeks ago. My No. 2 pick, Pilot Gold (NASDAQOTH: PLGTF), has just revealed extremely encouraging results from step-out drilling at the TV Tower project in Turkey to "extend the gold-rich zone in multiple directions." Sandstorm Gold (SAND 1.90%) and Pretium Resources (PVG) appear primed for particularly strong showings as well. And after reviewing key updates this week from both Goldcorp (GG) and Eldorado Gold (EGO 0.98%), I remain confident in the prospects for both stocks to comfortably outperform their peers during 2013.
