Despite initial short-term weakness, Janet Yellen's nomination as Federal Reserve chairwoman is a longer-term positive for precious metals and miners. Yellen advocates a more accommodative policy than the FOMC followed in the past. The nomination further entrenches the notion that the 2% inflation target is merely a longer-run goal and not an upper limit.
Expect Yellen to be a vocal and transparent leader. And expect this transparency to show a Federal Open Market Committee focused on extending the duration of low rates and increasing the size of asset purchases beyond current market expectations.
At an IMF conference in April, Yellen specifically discussed a movement away from the Taylor principle. In 1993, economics Professor John Taylor proposed that a 1% increase in inflation should be met by an increase of more than 1% in the nominal interest rate. Yellen stated:
The public might expect the federal funds rate to follow a path suggested by past FOMC behavior in "normal times" -- for example, the behavior captured by John Taylor's famous Taylor rule. I am persuaded ... that the policy rate should, under present conditions, be held "lower for longer" than conventional policy rules imply.
Yellen went further and stressed the committee's policy nuance regarding the inflation target (not cap) of 2%. The FOMC gave guidance in December 2012 that the federal funds rate should remain at zero until the unemployment rate reaches 6.5%, adding the caveat that inflation projections must remain below 2.5%. Simply put, Yellen is willing to accept elevated inflation if it yields gains in employment.
Yellen also indicated support for extending quantitative easing by characterizing the current program as innovative: "Two innovations in the FOMC's current asset purchase program, for example, are that it is open-ended rather than fixed in size like past programs, and that the overall size of the program is explicitly linked to seeing a substantial improvement in the outlook for the labor market."
And she noted that the central banks of England and Japan were also focused on purchasing their own long-duration securities. Because the other central banks are expanding their balance sheets at least as fast as the Federal Reserve, one could expect a strong dollar index despite inflationary pressures in the United States. Interestingly, the minutes from the September FOMC meeting indicate that total consumer price inflation picked up in recent months, though it remains modest.
Three metal hedges for the Yellen Fed
As with equities, there are many options to diversify into precious-metal investments. Consider investing in ETFs backed by physical metals, mid-cap miners, and coins or bars. Among the ETFs backed directly by physical gold, the SPDR Gold Shares ETF (NYSEMKT: GLD) is the largest. The ETF charges a reasonable 0.4% expense ratio and houses its gold with HSBC.
iShares Gold Trust (NYSEMKT: IAU) may be a better choice with its low 0.25% expense ratio, but the trust's custodian is JPMorgan Chase. JPMorgan has drawn the ire of metal proponents who claim the bank has obtained unfair position limits at the Commodity Exchange, has naked shorts in silver, and benefits from the canceling of high-frequency trades. While JPMorgan continues to face regulatory action on other fronts, it should be noted that the CFTC recently ended a multiyear investigation into silver-market manipulation without proving any allegations of impropriety.
Those looking to leverage an increase in precious-metal prices should consider the miners. While mining companies face political and technical difficulties, their earnings naturally increase by a multiple of any rise in the underlying metal price. One option is Randgold Resources (NASDAQ: GOLD), which continues to be profitable in a difficult price environment and boasts a strong balance sheet.
Last month, it officially poured its first bar at the Kibali project in the Democratic Republic of Congo. This project is significant in size to Randgold and should add 250,000 ounces of gold per year to a 900,000-ounce base in the coming years.
The main advantage of personally holding bullion is the lack of counterparty risks. Bullion coins, rounds, and bars can be bought from dealers for a premium to spot prices. The premiums range from 4% to 20% depending on collectability and mintages. A popular option for silver investors worldwide is the U.S. Mint's American Silver Eagle (pictured above). 2013 is on pace to be the most popular year for the Silver Eagle program, with more than 36 million ounces sold to date.
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