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Could Diminishing Returns From QE-3 Spark Gold Rally?

Based on the minutes of the December 17-18 Federal Open Market Committee Meeting (FOMC), the Federal Reserve appears to have acknowledged the diminishing returns from its monthly $85 billion bond buying program.

That being said, the question now becomes whether there’s any justifiable reason for the Fed to continue spending more good money after bad. With the Fed citing the potential for “excessive risk taking in the financial sector,” it’s hard to escape the irony that its decision to reduce the asset purchase program might just precipitate the very financial crisis it seeks to avoid, with gold likely being the main beneficiary.

DOWJAN8-2014The DOW and S&P 500 indexes both fell today in reaction to the release of the FOMC minutes while the US dollar index firmed, pushing gold lower. (As a general rule, gold tends to trade inversely to the US dollar: dollar strength equals gold weakness; dollar weakness equals gold strength). However it’s worth noting that there have been periods when gold and the dollar firmed together.

One question investors are asking themselves today is what impact the reduction in tapering will have on the broader market. When the DOW was getting hit earlier this week, gold was moving higher, suggesting perhaps some modest rotation out of general equities into gold.

Some of the miners haven’t been doing too bad either, portending maybe that the final bottom for this beat up sector might (at long last) be in. However, the miserable action in the gold market over the past year has left little room for complacency so nibbling in the market might be the best strategy until a more defined upward trend emerges.

Mergers and acquisitions activity is expected to increase this year as stronger, low cost gold  producers seek to offset production-based declines in their gold resources by way of takeovers. There are some great assets out there in safe political jurisdictions that are selling at fire sale prices and you can bet low cost producers like Goldcorp and Yamana are looking hard.

No doubt there are some good opportunities for royalty companies including Royal Gold, Franco Nevada and Silver Wheaton who have the capacity to finance new production in difficult market conditions for a piece of  commercial production.  In a gold recovery scenario, these companies generally lead their peers in terms of market upside.

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