Why is Gold held by the Central Banks?

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Why is Gold held by the Central Banks?

If one has looked into the gold market in recent years, one will likely have read that central banks are net buyers of gold. After years of selling the yellow metal these powerful financial institutions are now buying gold and holding it. Central banks are the largest players in the gold market, and if they are buying gold there is likely good reason.

 

Central banks have a great deal of responsibility. These mammoth institutions are responsible for monetary policy in their respective nations. Some central banks may be responsible for monetary policy in a group of different nations, such as the European Central Bank.

 

The scope of a central bank’s duties does not end with monetary policy. These banks are also expected to monitor and encourage employment, keep currency values stable and control inflation. In addition, central banks act as the primary bank of governments and oversee and manage the bank reserve and credit systems.

 

In Canada, the central bank is the Bank of Canada. In the United States, the central bank is the Federal Reserve.

 

The Bank of Canada’s responsibilities fall into a few categories. Its principle role is “to promote the economic and financial welfare of Canada.”  The categories for the Bank of Canada are as follows:

 

  • Monetary Policy-controlling the money supply
  • Financial System- promotion of safe and efficient financial systems
  • Currency- Issuance of Canada’s bank notes
  • Funds Management- The bank manages Canada’s foreign exchange reserves and public debt while acting as the fiscal agent of Canada

 

The United States Federal Reserve also has several categories outlined. These categories include:

 

  • Production of price stability and employment
  • Systemic risk control
  • Supervision and regulation of banks and financial institutions
  • Provide financial services to the U.S. Government

 

Although central banks have been net buyers of gold in recent years, some have a lot more gold than others. The Bank of Canada’s gold reserves, for example, pale in comparison to that of the United States. It should be noted, however, that the U.S. Federal Reserve does not own the gold but rather the U.S. Treasury does.

 

Whether through a central bank or a treasury department, many sovereigns own physical gold.  There are many different reasons that these large financial institutions may own physical gold. Some of these reasons may include:

 

  • Desire for credibility
  • Desire for stability
  • Reserve diversification
  • Hedging purposes

 

Gold is symbolic of power, value, economic credibility and prestige. The yellow metal has been recognized a reliable store of value for thousands of years, and can be exchanged anywhere in the world without counterparty risk.

 

China and its recent gold buying activities are a great example of what gold ownership may accomplish. China has been buying large amounts of gold in recent years, and although they have not publicly stated their gold holdings, some estimates put their reserves from 3000-8000 tons. This gold acquisition is likely an attempt by Beijing to boost the credibility of its currency, the yuan. The yuan is on the verge of being accepted as a global reserve currency and part of the IMF’s Special Drawing Rights.

 

The yuan could, in time, challenge the dollar as the preferred global reserve currency. The more gold that China has in reserves, the more likely such a scenario could become due to the fact that gold is viewed as a relatively stable asset.

 

Because of its history, inherent value and relative stability, gold may potentially provide central banks with a means of reserve diversification as well as global credibility.

 

The Dollar as the Reserve Currency of the World

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The Dollar as the Reserve Currency of the World

The U.S. dollar has enjoyed its status as the global reserve currency of choice for some time now. Since the implementation of The Bretton Woods Agreement, the dollar has been considered the anchor of the global financial system. Under this agreement, the United States guaranteed other central banks that they could sell their dollar reserves for a fixed rate of gold.

 

In the 1960s and 1970s, some flaws were seen in this system, however. The Triffin Dilemma was first identified in the 60s by economist Robert Triffin who believed that a conflict of interests undermined the system. According to Triffin, this conflict arose out of differences in short-term domestic objectives and long-term international objectives.

 

Triffin also pointed out that the country who was supplying other countries with its currency for reserve purposes must be willing to supply enough of the currency to fulfill global demand, and this extra supply of currency leads to a trade deficit.

 

This dilemma is often cited as one of the most-if not the most-significant problems with the Bretton Woods Agreement.

 

This eventually led to a balance of payments dilemma as well. The U.S. had to run a balance of payments current account deficit to ensure enough liquidity for the conversion of gold into dollars. The influx of dollars led speculators to believe that perhaps the dollar had become overvalued.  As more dollars were converted for gold, it also meant that the country’s gold reserves were not as robust. Less gold in the country led to even more concern about the dollar’s value, and the country had to run a balance of payments current account surplus in order to boost the dollar. Needless to say, the country cannot run a balance of payments current account deficit and surplus simultaneously.

 

Clearly the system was flawed, and in 1971 then-President Richard Nixon initiated “Nixon shock” under which dollars could no longer be exchanged for gold. This was, in effect, the demise of the Bretton Woods System.

 

The Petrodollar

As confidence in the dollar was a concern, President Nixon negotiated a deal with Saudi Arabia for all future oil sales to be dollar denominated. In exchange, the U.S. would provide Saudi Arabia with protection for its vast oil fields. Other OPEC members also followed suit. These agreements ensured that demand for U.S. dollars would remain robust, and helped to support the dollar’s value.

 

While demand for dollars has been strong due to the fact that nations need dollars in order to transact oil, this agreement also likely boosted demand for U.S. debt in the form of treasuries. The dollar’s reserve currency status as well as demand for U.S. debt has been advantageous for the U.S., as it has kept interest rates down, although a stronger dollar can have negative effects on exporters.

 

The Dollar’s Future as the Global Reserve Currency of Choice

There has been much discussion over the years about the dollar’s status as the preferred reserve currency of the world. The currency markets appear to be currently undergoing some significant changes, and the dollar could potentially be challenged.

 

Several nations have already begun a move away from dollars. China, Russia, even France have all set up swap lines to facilitate transactions outside of U.S. dollars. Even some multinational corporations have also taken similar measures.

 

Some believe, in fact, that the only issue preventing a direct challenge to the dollar is the ongoing petrodollar system. If Saudi Arabia and other oil producers made a move away from dollars, it could potentially set the stage for massive dollar depreciation as capital could flow out of dollars and into other currencies, while demand for U.S. treasuries could also potentially see a dramatic decline. If many of these dollars found their way back home, the rapid increase in supply could severely undermine the value of the dollar and possibly lead to rapid inflation in the U.S. as well as rising interest rates.

 

The Yuan as the Next Preferred Reserve Currency

It’s no secret that China has taken steps in recent years to bolster its position both economically and politically. The country has also been reportedly buying massive amounts of gold, although the country’s exact holdings remain unknown. Some estimates put China’s gold reserves at 3000 tons while others believe the country could be holding 8000 tons.

 

Whatever the case may be, it is possible that China is looking to bolster its gold reserves in an attempt to gain more credibility for its currency, the yuan.

 

On October 20th of this year, the yuan is set to become a member of the International Monetary Fund’s (IMF) Special Drawing Rights. This would mean that the yuan is now accepted as a global reserve currency and could potentially be the first step in a direct challenge to the dollar.

 

While much of this may be pure speculation at this point, it would not be far-fetched to see even more countries moving away from dollars and into yuan.

 

China is the world’s second largest economy, and has been experiencing rapid growth in recent years. As China looks to further cement its place among the global elite, it will likely continue to push for additional acceptance of the yuan as a preferred global reserve currency.

 

While the dollar remains the global reserve currency of choice, the currency could potentially see outflows into a viable alternative such as the yuan.

 

Clearly, China believes that owning gold is important. Gold is symbolic of power and prestige, as well as financial stability. As uncertainty over the dollar’s future as the world’s reserve currency mounts, gold may see additional demand from other nations as well as smaller investors looking to hedge against currency risk.

 

What Drives the Price of Silver?

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What Drives the Price of Silver?

Silver is a commodity, and like any other commodity, its price is a reflection of current supply and demand. Silver is somewhat unique in the precious metals space, however, as its value may be driven not only by investment demand but also industrial demand. This allows silver to potentially experience the best of both worlds. In a strong economy, industrial demand for silver may heat up and potentially drive prices higher. In a slow economy, or during times of risk aversion, silver may potentially benefit from investment demand as investors look for perceived safe havens to put capital to work in.

 

Silver Market Fundamentals: It is important to understand that while only a small portion of gold is used in industry, a very large portion of silver is used in modern day industry. Silver is used in jewelry, but is also utilized in an ever-increasing variety of industrial applications.

 

According to The Silver Institute, 95 percent of annual silver demand falls into just three categories. These categories are:

 

  1. Industry
  2. Investment
  3. Jewelry and Décor

 

Silver in Modern Industry: Recent years have seen more and more uses for this incredible metal becoming main stream. Silver is used in many products as well as sub-components of products, and we are now surrounded by this white metal. Here we will examine just a few of the thousands of potential uses for silver to demonstrate why demand for this metal may continue to rise:

 

Your car-tens of millions of ounces of silver are now used in cars every year. Electrical connections in your car are facilitated by silver contacts. Silver switches are used to perform such mundane tasks as starting your car’s engine, opening or closing your power windows and adjusting your seat. In fact, silver even makes it possible to see out your back window. Silver-ceramic lines are present in the rear windshield. These lines can be heated in order to melt snow or ice from the glass and maintain visibility. Even your car’s anti-freeze contains ethylene oxide, a compound made from silver.

 

Batteries- Modern technology has provided millions with the ability to do more. Many common everyday gadgets, like an iPhone or a watch, are powered by small batteries. Silver oxide batteries have been replacing the older lithium batteries. Silver oxide batteries are now widely used in watches, hearing aids, cameras and other small electronics. Silver oxide batteries provide a greater power-to-weight ratio, thus delivering more bang for the buck. Silver oxide batteries are also being used to phase out lithium ion batteries commonly used in laptop computers and cell phones. The silver oxide battery provides a superior power source with a favorable environmental footprint over other alternatives.

 

Switches- Silver is widely used in electrical switches. Silver is an excellent conductor of electricity and makes a great choice for television and light switches as well as circuit boards and plasma screen displays. Silver is very reliable, and may be used for millions of on/off cycles.

 

The world is growing, and as more developing nations such as China begin to utilize better technology, demand for physical silver in industry may continue to expand at a very rapid pace.

 

Silver in Jewelry: According to The Silver Institute, approximately 275 million ounces of silver was used last year in jewelry and silverware. Silver is highly sought after in these arenas for several reasons. Silver is a precious metal, and is more affordable than other types of metals. This provides jewelry makers and buyers with a cost-effective metal to use that is very durable and will stand up to the test of time and wear. Silver can be worn with almost anything, and all types of stones may be used in conjunction with the white metal. Silver may even have some health benefits, and is reportedly hypoallergenic and may have other healing properties. The metal is durable, easy to clean and looks beautiful.

 

Investment Demand: Silver is widely regarded for its investment value. Nearly 200 million ounces was reportedly used last year in coins and bars, and we would expect this number to continue to grow. Silver, like gold, has been recognized as a reliable store of value for thousands of years. Silver is not only recognized the world over, but is also traded and exchanged all over the globe. Physical silver as an investment may potentially offer numerous benefits. Some of the potential benefits include:

 

  • Lack of counterparty risk
  • Ease of acquisition
  • Liquidity
  • May potentially hedge against currency, economic or geopolitical turmoil

 

Silver has never been easier to acquire than it is today. Even those on a very limited budget can begin to build a precious portfolio. Silver is not only available everywhere, but it is also available in many forms. Silver can be bought for investment purposes in coin, bar or round form.

 

The world is an ever-changing place. As such, we would expect investment demand for silver to continue to grow along with industrial demand. Emerging markets, along with a potential shift in global currency markets may be some of the primary drivers of silver in the future.

 

Possibility of Retun to the Golden Standard

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Could There Be a Return to the Gold Standard?

In recent years, there has been seemingly more and more debate about the feasibility of returning to the gold standard. As concerns over the U.S. dollar mount, there may be further talk of such ideas, although whether or not they make sense and could be actually implemented is highly debatable.

 

To understand the implications of such a move, one must have an understanding of how the gold standard works. We will briefly outline the gold standard monetary system, and then discuss some of the potential pros and cons of such a system in today’s world, as well as some of the potential challenges that could be faced trying to implement such a system.

 

The Gold Standard in a nutshell…

 

The gold standard is a financial system in which each unit of currency is directly tied to an asset-in this case that asset is gold. Use of gold as money began thousands of years ago, and even to this day the commodity is recognized as money.

 

Under a gold standard monetary system, every single unit of currency would be backed by a specified amount of gold bullion. This accomplishes several things. Here are a few of the potential advantages of a gold standard system:

 

  • Under a gold standard system, price stability can be achieved and maintained. Because the government can only increase the money supply with a corresponding increase in gold holdings, any significant inflationary pressures are not likely to be seen, and any hyperinflation is essentially impossible. The overall lack of currency manipulation can keep prices stable while maintaining stable currency values.
  • The gold standard can help promote international trade. This monetary system can encourage international trade because participating countries operate on fixed exchange rates.
  • The gold standard can help prevent financial repression. This term refers to the transfer of wealth from creditors to debtors. This can be used to reduce debt, and is also considered to be a form of taxation. Having a gold-backed currency can prevent deficit spending and thus keep wealth with the people rather than with the government. Gold acts as a barrier to such practices, and given this fact it’s no wonder that many proponents of big government are opposed to such a system.
  • A gold standard keeps the government, its people and its leaders accountable.

 

While a return to the gold standard could have many potential benefits, it could also have some serious drawbacks. Some of the potential arguments against such a system include:

 

  • The gold standard can act as a barrier to economic growth. Once an economy has reached its productive capacity, it cannot grow further without a corresponding increase in its money supply. If a nation’s currency is directly tied to the amount of gold held by that nation, then limits on the gold supply could limit economic growth potential and severely hamper a country’s ability for economic expansion.
  • The gold standard can bring a degree of volatility to prices in the short-term.
  • Countries that produce gold may have a distinct advantage over non-producing countries.
  • Central banks would not have the ability to manipulate the money supply in order to fight economic contraction.
  • Because the money supply is based on gold production, inflation could be caused if gold production outpaces economic expansion. On the other hand, if economic growth outpaces the production of gold, then growth is constrained and could lead to deflation.
  • The devaluation of fiat currencies under a gold standard could be sharp and severe.
  • The gold standard limits a central bank’s capabilities when it comes to regulating inflation and deflation as well as dealing with economic crises.

 

While these pros and cons are only based on some of the arguments for and against a gold standard system, they provide a great degree of color on what implementation of such a system could entail.

 

Implementation of such a system in the modern era could prove to be extremely difficult. In order to move to such a system, the U.S., for example, would have to acquire enough gold bullion to back every single dollar currently in circulation. At the present time, that’s nearly $3 trillion dollars’ worth of gold.

 

The current gold reserves of the U.S. stand at approximately 260 million ounces, worth about $431 billion. The country would, therefore, have to go out to the open market and buy enough old to cover its liabilities; unfortunately, buying that much gold would only serve to further inflate the price of gold, making the transition even more expensive.

 

The other option would be to inflate the price of gold in dollars high enough to cover the current monetary base. If the gold price were to be inflated from current levels to $10,000 per ounce, it could have a significant negative impact on the economy, an impact that may be severe enough to fully wipe out the potential benefits of such a system.

 

While the arguments for a return to the gold standard will likely be ongoing, and anything is possible, given the difficulties associated with implementing such a system it is unlikely that a return to the gold standard will be seen any time in the near future.

The Chinese Demand for Gold

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Chinese Demand for Gold

China is the world’s second largest economy, and has taken steps to cement its place among the economic elite of the world. One of those steps has been the acquiring of gold. The country appears to have an insatiable appetite for the yellow metal, and has been building its gold reserves in recent years.

 

China has not published its actual gold holdings since 2009. At that time, the country reported that it held 1054 tons of gold. The country reportedly doubled its reserves during the 2008/2009 buying cycle. Recent estimates have ranged considerably, with some analysts believing the country holds over 3000 tons of gold, while other analysts believe that number may now exceed 8000 tons.

 

Whatever the case may be, it appears that China has been buying gold and doing so quietly. The question then becomes: Why is China buying so much gold and why are they not making it public?

 

For starters, gold has long been considered a way to project power. Desire for gold jewelry has also always been a consistent source of demand.

 

There does, however, appear to be something much larger at work here. Something that could potentially change the global financial system as we know it today…

 

China has likely been positioning itself, and its currency, the yuan, for a more prominent role in global finance and trade. In fact, the yuan is about to join other key global currencies, such as the dollar, yen and euro, as a member of the IMF’s Special Drawing Rights. Becoming a recognized global reserve currency could significantly bolster the yuan’s status, and in the process ensure that China is a key figure at the global bargaining table. The introduction of the yuan as a global reserve currency could potentially draw capital out of dollars and into the Chinese currency. As money flows out of dollars and into yuan, the dollar could potentially see a significant decline.

 

Although the dollar has been strengthening in recent months on the notion of higher rates and as other countries continue with quantitative easing programs, the introduction of a viable alternative reserve currency could have a significant and lasting effect on the U.S. currency. It’s no secret that a move away from the dollar is already under way. Several nations, such as China, Russia, even France, have already set up swap lines that facilitate transactions outside of dollars. Several global companies have also begun such moves.

 

There has been talk by many nations for some time to move away from the dollar, and it looks like that idea is finally gaining some real traction.

 

As China directly or indirectly challenges the U.S. dollar as the global reserve currency of choice, the more gold the country has in its possession, the more credibility its currency will have. China may even be going a step further – as the world’s largest consumer of gold and the world’s largest producer of gold, China may be seeing a way to control global currency markets through gold.

 

China has recently announced that it is seeking to establish a yuan-based gold fix. Such a gold fix can potentially have enormous implications on global markets.

 

The Shanghai Gold Exchange, or SGE, would operate much like the exchanges of the West, with one key difference, however. Unlike London, for example, the SGE will be sponsored by banks with direct Chinese Government support. Unlike the private banking structure that is used in London, the banks sponsoring the SGE are largely state-owned and are used as tools for central planning. While the SGE may appear to be operating a “free market” structure, the influence of the Chinese Government will likely play a major role in the gold price. What this means is that the Chinese Government will be able to increase or decrease the yuan-based gold price at their discretion. This further means that the dollar-yuan relationship would also have to change, since gold would be denominated in both currencies.

 

The power of the Chinese Government to influence global currencies and exchange rates would represent a significant shift in the balance of power from West to East. China is pushing its agenda, and gold plays a key role in that agenda. The nation will likely continue to buy and hoard gold as it looks to gain further power and global economic influence.

 

This ongoing saga is a clear demonstration of the power of gold. Gold ownership brings credibility and power to the global financial stage. Nations realize and understand the inherent value of gold, and therefore look to acquire and hold it…

 

Shouldn’t you?

What a Week

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What a week. It’s a new year for the world’s financial markets, but it sure didn’t take long for investors to realize that the themes of 2015 are still very much prevalent. The week and the year began with Chinese regulators attempting to maintain control of their currency as the offshore market continues to discount the official rate has seen investors sell Chinese stock markets and prompt fear of further weakness in the world’s second biggest economy. The immediate and pertinent questions as fear of contagion spreads around the globe is, are the events over the previous week indicating some sort of paradigm shift in the global economy like a crisis or is this simply volatility that is to be expected in 2016?

At this point, it seems the latter scenario of increased volatility is more likely. Furthermore, ending the week Friday with strong US job numbers only added credence to this point. As the US labour market created 292 thousand net jobs in December, the year of 2015 topped out as the second best year for job creation since 1999. The US economy continues to moderately advance as the least dirty shirt in an obstacle-ridden world.

The US Federal Reserve remains in their challenged position as the world’s central bank. As the IMF points out, global growth in 2016 will be muted and uneven, but domestically US businesses continue to have a positive outlook and hire. Hence, there is an environment to continue to support a strong dollar. Shifting overseas, part of the fear of the rapid currency depreciation in China, and other emerging markets is linked to local firms holding US dollar debt that inflates with currency weakness. This currency weakness is being prompted by diverging central bank policy between the US and the rest of the world. This has certainly been the dark cloud that has reappeared over financial markets, not unlike August and September of last year.

Chinese equities perhaps tell part of this story as they represent investors fleeing their domestic market, but don’t share a link to their economy that financial markets in more advanced economies may have. This is why they only an incomplete story. Proof of this is in the issues over the past week where circuit breakers and trading halts that failed to restore investor confidence and minimize what was an incomplete emotion-filled rush for the exits. As their equity markets require reform, it will be important for investors to keep this in mind in the year ahead and anticipate further violent moves. Chinese equities, while making headlines surrounding trading halts and selling bans, are only a small part of the story for global markets.

In retrospect, the outlook for the markets circles back to the US Fed and their interest rate policy. Despite the fact that we are now past the point of quantitative easing and emergency level interest rates, it is still the pace at which the US Fed continues to raise rates that will be the focus of investors. The unconventional measures of the past allowed the fed to maintain a liquidity backstop for global markets. This game is now changing as their ultra-accommodative measures are tapered back. Less liquidity prompts more volatility, and that is why in 2016 it is most important investors are tempered and have a plan for when the market sells off, instead of being caught in shock.

How Can I Diversify my Precious Metals Holdings?

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How Can I Diversify My Precious Metals Holdings?

 

What is Diversification?

Diversification is the careful consideration and combination of a wide range of investments within a portfolio in an attempt to smooth overall volatility.  Diversification is a broad term, however, and can be accomplished in different ways.

 

A retirement portfolio, for example, may contain a mix of stocks and bonds. The idea here being that if stocks are rising bonds may be falling and vice versa. In fact, many portfolios in the past have been constructed of just these two asset classes.

 

As investors have become more sophisticated and economic conditions have changed over the years, more and more investors began looking for other ways to diversify.

 

A stock portfolio, for example, could be further diversified by owning stocks from various areas of the economy such as oil and gas, healthcare, utilities and more. The idea here being that during times of economic prosperity and higher markets, stocks that benefit from consumer discretionary spending may outperform while companies involved in “staples” such as utilities, healthcare and food companies may underperform.

 

In a similar fashion, bonds and fixed income investments could be further diversified by owning bonds from different issuers with different rates and maturities.

 

Over the years, investors sought out even more ways to diversify. Some alternative asset classes that have been utilized in recent years include precious metals, real-estate and futures.

 

Precious metals are recognized today as an excellent vehicle for additional portfolio diversification. Just as it may be beneficial to have different stocks and bonds in a portfolio, it may also be wise to own a diversified basket of physical precious metals.

 

How this applies to Precious Metals

Diversifying a precious metals portfolio is simple and convenient. In order to best diversify your holdings, it is necessary to consider a few questions first:

 

  • What are my investment objectives?
  • Is liquidity important to me?
  • What is my time horizon?
  • Where will my metals be stored?

 

Once you have answered these questions, you can begin the process. Here we will discuss some ways to diversify a standard precious metals portfolio that one intends to own as a long-term investment.

 

Buy different types of metal: This would seem logical, yet many people get focused on just gold or silver when it comes to owning precious metals. Platinum and palladium may also serve a purpose within a portfolio. One can consider a mix of several types of metal for various reasons. Gold, for example, is used primarily in jewelry and for investment purposes. Silver, on the other hand, is used in jewelry, for investment purposes and in literally thousands of various industrial applications. It stands to reason, therefore, that during economic boom silver could potentially outperform gold while during times of risk aversion gold could potentially outperform silver. A portfolio consisting of different metals may potentially lower volatility within the portfolio.

 

Buy different forms of precious metals: Precious metals may be purchased in various forms including coins, bars and rounds. Coins from major mints are well-recognized, are legal tender and very liquid. Bars and rounds, on the other hand, may offer lower premiums and carry no face value. Coins and rounds may be more easily exchanged and transacted than larger bullion bars. If you hold large bullion bars in a depository, for example, you could also consider holding smaller quantities of coins and rounds at home or in an accessible and secure storage location.

 

Consider some graded coins or numismatics: Graded coins carry higher premiums than standard bullion coins. This is because they have gone through the grading process by a major grading company and are certified for authenticity and fineness. Graded coins may increase or decrease in value at different rates than non-graded coins.

 

Numismatic, or collectable coins, are typically bought for their scarcity and not just their precious metals content. These collectable coins may carry vastly higher premiums than standard bullion or graded coins. Their value, however, is based more on their scarcity and condition than bullion coins. These coins may retain or even increase in value in spite of lower gold or silver prices. Because their value is not based solely on the spot price of gold or silver, they may provide a means of diversification.

 

With a little research, time, and openness to other products, diversifying a precious metals portfolio has never been easier. Just as with any other type of investment, one should not put all of their eggs in one basket.

What is Qualitative Easing and How does it affect Markets?

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What is Quantitative Easing and How Does it Affect Markets?

Quantitative easing, affectionately referred to as “QE”, is a term that has been widely used in recent years. In fact, more people are likely familiar with this phrase than ever before. Given its coverage in the media, and its widespread use, we felt it prudent to provide a simple explanation of what QE is and how it can affect financial markets.

 

What exactly is Quantitative Easing?

Quantitative easing is a tool used by central banks in order to try and boost economic activity. The way QE works may seem difficult to comprehend, but is relatively simple. To perform quantitative easing, banks purchase securities from banks (such as government bonds) and pay for these securities with electronic funds that did not previously exist. In other words, with the click of a button, the central bank is able to print money out of thin air. This newly created money is designed to boost the amount of bank reserves. The bank, in turn, is then supposed to make more loans because it has more capital in reserve. The bank may also purchase new assets to replace those sold to the central bank. It is thought that these bank purchases, as well as higher loan activity, will cause stock prices to rise and interest rates to fall.

 

QE may be used more as a method of last resort. Under normal economic conditions, central banks may be able to control the money supply through interest rates. As the economic crises began to take hold in 2008, central banks slashed interest rates to zero or near-zero levels. That, however, did not prove to be enough. QE then began being used as a tool to get banks to lend more and spur economic activity.

 

It is not yet known whether quantitative easing was truly effective or not…

 

Some would argue that QE did, in fact, boost output and lending while other analysts believe that is was largely ineffective.

 

Perhaps even more important now is how central banks begin to step back from such measures. If the additional cash that has flooded markets began to circulate more rapidly, it could spur inflation. In addition, once central banks begin to unwind their balance sheets (selling the assets they have accumulated) interest rates could potentially soar and cause any economic recovery to falter.

 

It remains to be seen just how central banks will accomplish the unwinding of balance sheets, and it is a cause for concern.

 

Some analysts believe that the multi-year rally seen in equities has been a result of QE and low interest rates. QE may boost demand for stocks and other assets, especially in the face of low interest rates.

 

While that may very well be true, and QE may drive risk-taking and investment, it has not been proven. Just look at Japan, or the fact that several rounds of QE in the U.S. have thus far not been able to ignite inflation.

 

QE is ongoing in some nations, with the European Central Bank recently announcing another, larger round of bond purchases.

 

Time will tell just how effective, if at all, QE is. In addition, stepping back from QE may prove challenging for central banks, and could potentially cause higher interest rates, lower stock prices and risk-aversion while dampening economic activity.

What the End of the Stock Market Rally might mean for Precious Metals

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What Might the End of the Stock Market Rally Mean for Precious Metals?

Global equity markets have been on a tear in recent years, with the benchmark U.S. SP 500 index having made solid triple digit returns over the span of the last several years. Markets have been climbing since the 2009 lows, and continue to make new all-time highs.

 

This run higher in the equity markets as well as current valuation levels obviously begs a few questions:

 

-Will the rally continue?

-Are stocks overpriced at current levels?

-Is this a set up for a nasty correction?

-What has driven such significant upside?

 

We feel it is important to address some of these questions, as we believe the day will come when equity investors once again run for the exits. In turn, we believe that gold and precious metals could stand to benefit handsomely if and when this does in fact occur.

 

The stock rally is now in its seventh year. To put this into perspective, the average bull market lasts five years. Stocks have seemingly risen non-stop over the last half-decade, and new all time highs have been discussed widely in financial media circles.

 

We believe, however, that what goes up often comes down. Given the extent of the rally, many of the economic problems that still exist and the underlying factors driving the rally, we believe it is only a matter of time before this rally has run its course.

 

With regards to stocks being overvalued at current levels, once could certainly make the argument that equities have become expensive. To shed some light on this subject, let’s look at current price-to-earnings ratios, both trailing and forward.

 

The current 12 month trailing P/E ratio for the SP 500 is a tad over 19. The historical average for this number is 15.5. The forward P/E ratio for the SP is currently at 17, while the average over the last decade has been 13.5.

 

While simply looking at this data can be deceiving and may not give one the true lay of the land, it does indicate that perhaps stocks have become rich. Adding some credibility to this notion is the fact that stocks have not undergone a true correction in some time. In fact, stocks have not entered “correction” territory (defined as a 10 percent drop) since 2011.

While we cannot see the future, we do believe that stocks will not continue higher indefinitely. We believe it is only a matter of time before stocks reverse course.

 

Stock markets could, in fact, be setting up for a large reversal-a reversal that may catch many off-guard-that could begin to take shape anytime now…

 

We feel it is important to understand what has driven the rally to put this into context. The U.S. and many other countries have taken significant measures in order to try to boost economic activity. Quantitative easing as well as extremely low interest rates have been used in an attempt to fuel economic output. While some would argue that these measures have proven effective, others would say that significant problems still exist, and that the rally has been “artificial.”

 

Perhaps we are close to finding out…

 

The U.S. is nearing its first interest rate hike in years. The Federal Reserve appears to be on track for an initial hike of 25 basis points in the coming months-perhaps as soon as July or September.

 

Once the Fed does act, stocks may begin to falter. As the era of free money comes to a close, it may send investors looking elsewhere. Many who have ridden large portions of the multi-year rally may be the first to cash out.

 

Once capital begins to flow out of the equity markets, investors will likely be looking for alternative places to put cash to work. Alternative assets like gold and silver could potentially see a massive influx of investment capital.

 

While gold has been trending lower during this period of higher stocks, we expect the inverse correlation of gold to stocks to hold true.

 

The gold market does appear to be in the basing process when looking at recent price action, and investors have been buying the yellow metal on dips. The market does not appear to be headed lower, and we suspect that once capital starts flowing out of stocks, the gold market may once again turn higher.

 

In fact, we believe that gold will resume its long-term uptrend, and that now could represent one of the most opportune times to buy gold.

 

As the stock market approaches its eventual top, now is the time to be considering alternative asset classes for diversification. Gold has stood the test of time as a reliable store of value in good times and in bad, and we believe may provide an excellent investment opportunity at current levels for the long-term investor.

Why Use a Depository?

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Why use a Depository?

When purchasing precious metals, buyers must take into consideration where they intend to store their gold, silver or other metals.

 

While many may elect to store their metals at home or in a safe deposit box, this can become more challenging if larger quantities are being purchased. While the accessibility of home storage can be quite appealing, it does also represent a security concern. A safe deposit box, on the other hand, may offer superior security but comes with more limited access.

 

While using a depository to store your precious metals does not provide immediate access to your metals, it does offer a cost-effective and secure solution to your precious metals storage needs.

 

What Exactly is a Depository?

A depository is a third party facility that stores and secures precious metals for a fee. A depository can store both large and small amounts of gold, silver and other precious metals in various forms.

 

A depository may offer storage in either segregated or non-segregated accounts. A segregated account is an account in which your precious metals are stored by themselves, completely separate from the metals of other customers or any depository holdings. A non-segregated account, on the other hand, will store your precious metals in communal areas along with precious metals belonging to other account holders.

 

The decision on whether to use a segregated or non-segregated account may depend on personal preference, types of bullion being stored and fees associated with such accounts.

 

There are many depositories available for storage of your precious metals. Your choice of depository may depend on your location and a comparison of fees. Some of the more popular depositories include:

 

–          The Delaware Depository

–          Brinks

–           HSBC

–          JP Morgan Chase Bank

–          ScotiaMocatta Depository

 

What are some Advantages offered by a Depository?

Storing your gold, silver or other precious metals in a depository can have numerous advantages. Here we will outline some of these potential advantages:

 

Security: A precious metals depository is in the business of holding and safeguarding your precious metals. These depositories utilize state-of-the-art security technology to keep your metals secure. Measures such as constant, 24 hour surveillance, entry and exit records as well as security personnel may be used. The risk of loss or theft when using such a facility is extremely remote.

 

Insurance: Many depositories offer insurance coverage to further protect your gold, silver or other precious metals. Insurance coverage is an added layer of protection that can cover losses in the unlikely event of loss, damage or theft. Different depositories may offer different forms and levels of coverage, and one should become familiar with insurance policies and coverage when choosing a depository.

 

Auditing and Record Keeping: A precious metals depository goes to extensive lengths to properly store, maintain and account for all the metals it holds. Periodic inventory checks can alert the depository to any potential missing inventory quickly.

 

Ability to store large amounts of Bullion: For larger holdings of precious metals, a depository may be preferable to other storage methods. When storing precious metals at home, space can be a serious limitation as well as the security issues that come with it. In addition, home storage is more likely to lead to loss or theft. A depository can handle even the largest amounts of gold, silver or other metals safely and securely.

 

Peace of Mind: Due to their security, accounting and insurance measures, a depository can provide the owner of precious metals with peace of mind. One can sleep well at night knowing their precious metals are secure and accounted for.

 

Some types of precious metals purchases such as purchases made within an IRA account must be stored within an approved depository. If you are purchasing gold, silver or other metals outside of an IRA account, precious metals depositories represent a secure storage solution that should be considered along with other storage options.