London, 22 September 2010

While the US Federal Reserve yesterday chose not to explicitly outline further quantitative easing measures, the ‘do-whatever-it-takes’ rhetoric presented by the Federal Open Market Committee (FOMC) implies that such actions may not be far off. This sentiment alone was enough to spur investors towards safe-haven buying, pushing gold past the $1,290 mark.

If and when this “additional accommodation” discussed by the FOMC occurs, the reasoning will be more about a stealth devaluation of currency than a boost for consumer spending. A move like this should provide further support for gold in the near-to-medium term.

On the surface, the Fed would likely explain this move as necessary to stimulate consumption. As we all know, a lower interest rate typically means lower borrowing costs, which would lead to people spending more freely.

This time it’s different.  Credit cards are already maxed out.  American consumers cannot afford to borrow any more. Companies are not spending more either.  Instead, they’re taking advantage of exceptionally low interest rates to sell debt and hoard more cash, pay out dividends, buy back stock or acquire other companies.

So, why then would the Fed choose to pursue further quantitative easing?  It really comes down to currency devaluation.

If there is no domestic demand, then US needs to find demand elsewhere.  Cheaper currency is the only immediate tool at disposal to improving export competitiveness.

The US isn’t the only one who has figured this out.  The whole world is aware of this dynamic and many major countries are eyeing one another to see how they should game their currency.

Japan has made it known to the world that it wants to depreciate its currency.  Switzerland has expressed concerns for months.  New Zealand, Australia and South Africa have cited currency strength as a reason to hold off on interest rate hike.

As the whole world races to undercut each other’s paper currency, the only currency that isn’t freely printed by a political body will continue to benefit and that is gold.

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Where the analyst has expressed views and opinions, these may change and are not necessarily representative of Castlestone Management’s views.