Gold and silver prices benefiting from liquidity flood

[Barron]

2012-FEB-24

Gold coins For the first time in three years the slowdown in the eurozone is negatively affecting trade with important Asian exporters such as Japan, China, South Korea and Thailand. Owing to last year's floods, in Q4 Thailand’s economy suffered a 10.7% slowdown in comparison with the previous quarter. Recent factory closures have also caused difficulties for the Thai economy.

Meanwhile, Japan's exports dropped by 9.3% in January – a record monthly fall. Japan’s current account deficit now stands at US$19 billion. In order to boost exports the Bank of Japan recently announced a $130 billion expansion of its bond-purchasing programme. This is designed to weaken the yen. The People's Bank of China is also loosening its monetary policy by lowering bank reserve requirements. Investors are also confident that the US Federal Reserve will follow these steps and announce a third round of bond purchases soon.

Should this be the case, the Japanese will again face the problem of trying to halt the appreciation of their currency against the dollar. As a consequence, even more liquidity will flood the capital markets. In addition, many other Asian banks have started lowering interest rates in order to fight the problems affecting their economies owing to the eurozone crisis.

The European Central Bank is trying to gain control over the continent’s sovereign debt crisis by feeding the European banking system with three-year credit at very low interest rates, with a new package of loans scheduled to be unveiled at the end of this month. It is hoped that European banks will use this cheap liquidity to purchase bonds of financially stricken states such as Portugal, Spain or Italy. These loans are also designed to shore up confidence in Europe’s fragile banking sector.

Growing geopolitical tensions in the Middle East are, however, complicating central bank plans, with oil prices moving steadily higher. Sabre-rattling is increasing, with Iran recently announcing a halt to crude oil exports to the United Kingdom and France. Rising inflation expectations are having a positive impact on precious metals prices. By providing the markets with copious amounts of new liquidity, central banks are fuelling investors' fears of future inflation.

Gold and silver prices have resumed their upward trend following recent months’ correction patterns. In yesterday's session at the New York Comex the gold price hit a new five-month high, and is currently trading around light resistance at $1,780 per troy ounce. The silver price climbed by 1.5% and managed to break important resistance at $35 per ounce. From a technical point of view this development opens the way for further gains towards the $40 mark.