How Big is Gold's QE Premium?

What will happen to gold post Jackson Hole is the question on many commentators’ lips at the moment, here are a few scenarios.


When the Fed’s Jackson Hole meeting
concluded two years ago, it was with the announcement of QE2 by Fed
Chairman, Ben Bernanke. And, judging by the performance of the yellow
metal over the last few days, there is a hope on the part of many that
something similar might be announced at the end of this week’s meeting.

As UBS’s Edel Tully wrote yesterday, “The
metal’s QE premium is very real, and we question how much more can be
expected before Friday. Gold is currently trading where some would have
estimated after a Jackson Hole symposium which offered some QE crumbs.”

But, it is worth pointing out, as Tully
does that, while there has indeed been an increase in speculative
activity pushing gold higher since the release of the latest set of FOMC
minutes, there are other positive factors standing in gold’s corner.

“There’s still a lot in gold’s favor.
Dollar weakness, some European optimism (for now), momentum, technicals
and the strongest ETF buying this year are individually very supportive,
and certainly help squash some concerns that all we’ve really seen is a
spec buying splurge with a short-lived attention span.”

Indeed, “what happens after Jackson Hole?”
is the question on everyone’s lips. Consensus seems to be that, should
there be an announcement of further stimulus measures, whether in the
form of QE3 or something else, the reaction is likely to be strongly
positive for gold.

Standard Bank, in its aptly named Gold
price probabilities note, released today, says, “At this time, we do not
believe that gold is pricing fully further monetary stimulus from the
Fed. Therefore, we expect more upside from gold depending on (a) further
QE or some other type of stimulus and (b) the magnitude of any such QE
or stimulus. A $500bn expansion of the Fed’s balance sheet would
increase our fair-value estimate for gold by $80.”

The bank estimates that, were $500bn
dollars be added to the balance sheet, there is only a 30% chance of a
gold price less than $1,700, with a 58% likelihood of a price less than
$1,750.

UBS, on the other hand expects prices to
ratchet up sharply in such a scenario saying, that it would expect its
three-month forecast of $1750 to be quickly realized.

However, if the Fed does not implement a
new bout of easing, both UBS and Standard Bank expect gold prices to
come off somewhat, although both admit that the extent of the fall
depends on the content of the statement.

If the Fed hints that further stimulus
measures are not imminent, UBS says, “This is the outcome that would
certainly sour the mood towards gold. Expect a sharp sell-off, and the
risk that gold falls below $1600 with little supportive buying
emerging.” But, it does not expect this to happen.

The bank’s base case is that the Bernanke
will elaborate extensively on how the discount window may be deployed to
provide subsidized bank funding.

This it says would allow for some balance
sheet expansion, but not as much as markets are hoping for under a new
round of QE and, it wouldn’t be dollar negative.

“Expect gold to lose some its recent fever
and soften, but investors to be tempted to buy the dips closer to
$1620/1630, around where it broke out recently,” it writes of such an
eventuality.

Standard Bank says, “In the event of no
further stimulus, we’d see gold’s fair value at $1,660 – up from $1,650
in July,” adding, “Without further Fed stimulus, we’d see a 38%
probability of gold moving below its 200-day MA [$1,642 currently] level
within the next month.” But, if it did move below this level it would
consider liquidating its long positions.

However, it adds, “Should the gold price drop below $1,600 in this time, we’d consider scaled-down buying again.

Geoff Candy
August 30, 2012
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