How Obama and Manmohan will drive up the price of gold

If Obama wins and our government continues to worsen the budgetary gap - as seem likely - gold bulls should be in high spirits

Vivek Kaul September 11, 2012 08:58:51 IST
How Obama and Manmohan will drive up the price of gold

'Miss deMaas,' Van Veeteren decided, 'if there's anything I've learned in this job, it's that there are more connections in the world than there are particles in the universe.' He paused and allowed her green eyes to observe him. 'The hard bit is finding the right ones,' he added. - Chief Inspector Van Veeteren in Hkan Nesser's The Mind's Eye

I love reading police procedurals, a genre of crime fiction in which murders are investigated by police detectives. These detectives are smart but they are nowhere as smart as Agatha Christie's Hercule Poirot or Sir Arthur Conan Doyle's Sherlock Holmes. They look for clues and the right connections, to link them up and figure out who the murderer is.

And unlike Poirot or Holmes they take time to come to their conclusions. Often they are wrong and take time to get back on the right track. But what they don't stop doing is think of connections.

Like Chief Inspector Van Veeteren, a fictional character created by Swedish writer Hkan Nesser, says above "there are more connections in the world than there are particles in the universe... The hard bit is finding the right ones."

The murder is caught only when the right connections are made.

How Obama and Manmohan will drive up the price of gold

Gold is rising in dollar terms primarily because the market expects Ben Bernanke to resort to another round of money printing. But at the same time it is important that Barack Obama wins the Presidential elections scheduled on 6 November 2012.

The same is true about gold as well. There are several connections that are responsible for the recent rapid rise in the price of the yellow metal. And these connections need to continue if the gold rally has to continue.

As I write this, gold is quoting at $1,734 per ounce (1 ounce equals 31.1 gm). Gold is traded in dollar terms internationally. It has given a return of 8.4 percent since the beginning of August and 5.2 percent since the beginning of this month in dollar terms. In rupee terms gold has done equally well and crossed an all-time high of Rs 32,500 per 10 gm.

So what is driving the price of gold?

The Federal Reserve of United States (the American central bank like the Reserve Bank of India in India) is expected to announce the third round of money printing, technically referred to as quantitative easing (QE). The idea is that with more money in the economy, banks will lend, and consumers and businesses will borrow and spend that money. And this in turn will revive the slowing American economy.

Ben Bernanke, the current Chairman of the Federal Reserve, has been resorting to what investment letter writer Gary Dorsch calls "open mouth operations" - i.e. dropping hints that QE-3 is on its way, for a while now. The earlier two rounds of money printing by the Federal Reserve were referred as QE-1 and QE-1. Hence, the expected third round is being referred to as QE-3.

At its last meeting held on 31 July-1 August, the Federal Open Market Committee (FOMC) led by Bernanke said in a statement, "The Committee will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability." The phrase to mark here is additional accommodation, which is a hint at another round of quantitative easing. Gold has rallied by more than 8 percent since then.

But that was more than a month back. Ben Bernanke has dropped more hints since then. In a speech titled Monetary Policy since the Onset of the Crisis, made at the Federal Reserve Bank of Kansas City Economic Symposium at Jackson Hole, Wyoming, on 31 August 2012, Bernanke said: "Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability."

Central bank governors are known not to speak in a language that everybody can understand. As Alan Greenspan, the Chairman of the Federal Reserve before Bernanke took over, once famously said, "If you think you understood what I was saying, you weren't listening."

But the phrase to mark in Bernanke's speech is "additional policy accommodation," which is essentially a euphemism for quantitative easing, or more printing of dollars by the Federal Reserve.

The FOMC, in its 1 August statement, more or less said the same thing. Why didn't that statement attract much interest? And why did Bernanke's statement at Jackson Hole get everybody excited and has led to the yellow metal rising by more than 5 percent since the beginning of this month.

The same speech in a different year

The answer lies in what Bernanke said in a speech at the same venue two years back. "We will continue to monitor economic developments closely and to evaluate whether additional monetary easing would be beneficial. In particular, the Committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly," he said.

The two statements have an uncanny similarity to them. In 2010 the phrase used was "additional monetary accommodation". In 2012, the phrase used became "additional policy accommodation".

Bernanke's August 2010 statement was followed by the second round of quantitative easing or QE-2 as it was better known. The Federal Reserve pumped in $600 billion of new money into the economy by printing it. Drawing from this, the market is expecting that the Federal Reserve will resort to another round of money printing by the time November is here.

Any round of quantitative easing ensures that there are more dollars in the financial system than before. To protect themselves from this debasement, people buy another asset; that is, gold in this case, something which cannot be debased. During earlier days, paper money was backed by gold or silver. When governments printed more paper money than they had precious metal backing it, people simply turned up with their paper at the central bank and demanded it be converted into gold or silver. Now, whenever people see more and more of paper money, the smarter ones simply go out there and buy that gold. Also, often this lot of investors doesn't wait for the QE to start. Any hint of QE is enough for them to start buying gold.

But why is the Fed just dropping hints and not doing some real QE?

The past two QEs have had the blessings of American President Barack Obama. But what has held back Bernanke from printing money again is some direct criticism from Mitt Romney, the Republican candidate against the current incumbent.

"I don't think QE-2 was terribly effective. I think a QE-3 and other Fed stimulus is not going to help this economy...I think that is the wrong way to go. I think it also seeds the kind of potential for inflation down the road that would be harmful to the value of the dollar and harmful to the stability of our nation's needs," Romney told Fox News on 23 August.

Paul Ryan, Romney's running mate, also echoed his views when he said "Sound money... We want to pursue a sound-money strategy so that we can get back the King Dollar."

This has held back the Federal Reserve from resorting to QE-3, because come November Bernanke will be working with Romney or Obama. Romney has made clear his views on Bernanke by saying that "I would want to select someone new and someone who shared my economic views," as we noted before.

So what are the connections?

So gold is rising in dollar terms primarily because the market expects Ben Bernanke to resort to another round of money printing. But at the same time it is important that Barack Obama wins the Presidential elections scheduled on 6 November 2012.

Experts following the US elections have recently started to say that the elections are too close to call. As Minaz Merchant wrote in the Times of India article: "Obama's steady 3 percent lead over Romney has evaporated in recent opinion polls... Ironically, one big demographic slice of America's electorate could deny Obama a second term as president: white men. Up to an extraordinary 75 percent of American Caucasian males, the latest opinion polls confirm, are likely to vote against Obama... the Republican ace is the white male who makes up 35 percent of America's population. If three out of four white men, cutting across Democratic and Republican party lines, vote for Mitt Romney, he starts with a huge electoral advantage, locking up over 25 percent of the total electorate." (You can read the complete piece here)

If gold has to continue to go up, it is important that Obama wins. And for that to happen it is important that a major portion of white American men vote for Obama. While the Federal Reserve is an independent body, the Chairman is appointed by the President. Also, a combative Fed which goes against the government is a rarity. So if Mitt Romney wins the elections on 6 November, it is unlikely that Ben Bernanke will resort to another round of money printing unless Romney changes his mind by then. And that would mean a significant rally in gold.

But even all this is not enough

All the connections explained above need to come together to ensure that gold rallies in dollar terms. But gold rallying in dollar terms doesn't necessarily mean returns in rupee terms as well. For that to happen the Indian rupee has to continue to be weak against the dollar. As I write this one dollar is worth around Rs 55.5.

At the same time, an ounce of gold is worth $ 1,734. As we know one ounce is worth 31.1 gm. Hence, one ounce of gold in rupee terms costs Rs 96,237 ($ 1,734 x Rs 55.5). (This calculation, for the ease of understanding, does not take into account the costs involved in converting currencies, or taxes for that matter.)

If one dollar was worth Rs 60, then one ounce of gold in rupee terms would be worth around Rs 1.04 lakh. If one dollar was worth Rs 50, then one ounce of gold in rupee terms would have been Rs 86,700.

So the ideal situation for the Indian investor to make money by investing in gold is that the price of gold in dollar terms goes up, and at the same time the rupee either continues to be at the current levels against the dollar or depreciates further, and thus spruces up the overall return.

For this to happen Manmohan Singh has to keep screwing the Indian economy and ensure that foreign investors continue to stay away. If foreign investors decide to bring dollars into India then they will have to exchange these dollars for rupees. This will increase the demand for the rupee and ensure that it appreciates against the dollar. This will bring down the returns that Indian investors can earn on gold. As we saw earlier at Rs 60 to a dollar, one ounce of gold is worth Rs 1.04 lakh, but at Rs 50, it is worth Rs 86,700.

One way of keeping the foreign investors away is to ensure that the fiscal deficit of the Indian government keeps increasing. And that's precisely what Singh and his government have been doing so far. At the time the budget was presented in mid-March, the fiscal deficit was expected to be at 5.1 percent of GDP. Now it is expected to cross 6 percent. As The Times of India recently reported, "The government is slowly reconciling to the prospect of ending the year with a fiscal deficit of over 6 percent of gross domestic project, higher than the 5.1 percent it has budgeted for, due to its inability to reduce subsidies, especially on fuel. Sources said that internally there is acknowledgement that the fiscal deficit...would be much higher than the calculations made by Pranab Mukherjee when he presented the Budget." (You can read the complete story here).

To conclude

So for gold to continue to rise there are several connections that need to come together. Let me summarise them here:

1. Ben Bernanke needs to keep hinting at QE till November

2. Obama needs to win the American Presidential elections in November

3. For Obama to win the white American male needs to vote for him

4. If Obama wins, Bernanke has to announce and carry out QE-3

5. With all this, the rupee needs to maintain its current level against the dollar or depreciate further.

6. And above all this, Manmohan Singh needs to keep thinking of newer ways to pulling the Indian economy down. So far he hasn't done too badly in ruining the economy.

Vivek Kaul is a writer and can be reached at vivek.kaul@gmail.com

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