Will the end of US quantitative easing cause gold price collapse?

It is widely recognised that quantitative easing (QE) in the US has unleashed humungous dollars on the market; and with too much money going around chasing investment opportunities, commodities have been a good target.

No wonder, commodity prices are up sharply with large funds flowing into this new asset class. Gold has of course been a big beneficiary of the US easy money policy.

Belief is now gaining ground that soon the US Federal Reserve will be forced to review its policy, something that is sure to be critical for all markets.

Now, with the end of the US quantitative easing in sight, how will the commodity market, particularly gold, respond?

According to experts, a very low interest rate environment is one of the key reasons why many invest in gold bullion, given the low opportunity cost of investing in a non-yielding asset and the high tail risks associated with extraordinary monetary policy settings. Given the sensitivity of gold to information, even a hint of change in the supportive environment will impact the market.

However, with the US economic recovery still hesitant and unemployment rate still high, albeit falling marginally, more evidence of a sustained growth and employment generation may be necessary for a serious review of the monetary policy with a view to reversing it. There is merit in the belief that such a situation – tightening of credit – is likely to arise not earlier than the last quarter of 2011 or the first quarter of 2012.

It may be argued that QE may be an important driver of gold prices; but it is by no means the sole driver. For the yellow metal, there are other supportive factors such as unresolved sovereign debt crisis in Europe, continuing geopolitical instabilities in MENA region with potential to escalate, high crude oil prices building inflationary environment and purchases by central banks of some countries coupled with lower sales by the European Central Bank.

Would it be safe to assert that even if QE (1 and 2) were to come to an end over the next 2-3 quarters, its impact on the gold market may not be as catastrophic as generally assumed, provided other supportive conditions persist?

One needs to closely look at the effect of QE conclusion on other critical markets such as currency and equities. If equity markets were to improve, it is likely that less-committed investors in gold will liquidate and migrate to equities. It has happened in the past.

While a stronger US economy and equity market would help the dollar appreciate and prove counter-productive for gold, it is important to closely track the Chinese yuan. If RMB appreciates, it would make imports into China cheaper. Admittedly, over the last several months, tightening in China has been through credit restrictions while currency appreciation has been rather low. Any change of policy that may favour faster appreciation of RMB may have implications for gold prices.

In sum, on current reckoning, it is better to keep an open mind about the likely impact of the end of QE on gold.

There indeed are conflicting forces that can pull the gold market in opposite directions. At the moment it is still unclear which force will win. But trading in gold and benefiting from its price performance may not be the same again after the end of QE.

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