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Minyan Mailbag: Central Banks' Effect on Gold

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Monetarily depreciating the base value of a currency with increased money supply is bullish for gold.

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Greg,

I have a question regarding something you wrote in "Supportive to Gold." You said that central banks cutting short term interest rates is supportive for gold. I'm a bit unclear on this matter. I surmise that central banks lowering interest rates would increase the money supply because money is cheaper. Increased money supply acts to devalue currencies because of the relative ease to access money. My guess is that this is gold bearish because it's more stable relative to currency, especially currencies losing value.

Is this evaluation in line with your proposal?

Thanks,
Minyan Dylan


MD,

Thanks for your inquiry.

You've got most everything "correct," except your final assessment! (Perhaps you meant to say, bullish at the end, rather than bearish?)

Monetarily depreciating the base value of a currency with increased money supply (a direct result of cheaper credit, at least until the demand for credit has been saturated, a la Japan, and borrowers no longer seek to borrow), is bullish for gold. For that very reason it 'cheapens' the 'value' of paper currency (merely an IOU, one that used to be 'backed' by gold) relative to something tangible against which that value might be 'measured.'

It is also bullish for commodities in general, though this applies more in the sense of the currency in which those commodities are 'transacted' (usually the USD).

And this is bullish for stocks as well, at least to a point, particularly these days when the stock market has become increasingly "commoditized."

Nonetheless, it is more bullish for gold than stocks, on a relative basis, since stocks are a type of paper "currency" too (the currency of corporations, which I call 'equity scrip').

Of course, with all macro-monetary fundamental analysis there are 'caveats' (which in this case would be when a central bank is cutting rates in response to a worsening disinflationary environment where credit is not in 'demand'), and they are trying to stimulate such, with no success.

In that case, cutting rates in and of itself might not be bullish at all, but rather, might reflect a bearish macro-backdrop that is driving the value of gold lower on a nominal price basis.

Keep in mind, any and all paper currencies can be, and are, valued relative to gold...so one man's bullion bullish environment might be another man's bearish bullion environment.

Indeed, this is exactly why the most recent bull market in gold is so exciting (or scary), because gold has been appreciating relative to almost every paper currency on the planet.
This reflects the globalization in the rampant growth and availability of ever cheaper credit.
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