Mis-Judging the Gold Market

Gold is so misunderstood.

My colleagues and I often joke about how gold is the "all-weather" investment. When the economy is good, pundits claim gold will rise because of inflation. When the economy turns bad, gold bugs claim it will soar on safe-haven buying. According to conventional wisdom, there is no losing scenario for the yellow metal.

We saw more mis-judgement on the gold market yesterday.

Many analysts seized on the Federal Reserve's Open Market Committee announcement as evidence of good things to come for gold. The Fed said in the speech that it will continue supporting the U.S. bond market, by using interest from Fed-hold mortgage-backed securities to purchase government bonds.

There was a lot of news about why this will be good for gold. Essentially that the Fed is creating money to give to the government (via bond sales). The government will spend this money, unleashing it "onto the street" where it will cause inflation. Hard assets like gold should soar.

But this is not the case. The Fed is not creating new money. It is using interest payments on mortgage securities to buy bonds.

These interest payments come to the Fed from one of two sources. Either from government agencies who issued the securities, or from the private sector who own the underlying assets.

This means whenever a payment goes to the Fed, it is being taken off the street. Either drained from government coffers (in the case of payments from agencies), or from the economy (in the case of private-sector payments).

The Fed then turns around and buys bonds. Injecting this money back into the government, and (possibly) eventually into the economy.

But the net sum of money out in the world remains the same. For every dollar unleashed on the planet, a dollar is siphoned out of the system.

Creating money is inflationary and good for gold. Cycling money between different hands is not.

By. Dave Forest of Notela Resources