As far as gold is concerned, QE3 would be bullish


Following the poor economic data in the US, break even inflation (as derived from the bond market) is falling. Two-year break even inflation is down from 2.5% a month ago, to 1.8% yesterday. Ten-year UST yields are at their lowest level this year. Yesterday’s weak employment numbers and falling inflation expectations have intensified talks of possible QE3 by the Fed.

As far as gold is concerned, QE3 would be bullish. Our analysis suggests that for every $500bn by which the Fed expands its balance sheet, gold would make a step-change of $80-$100. Even at $1,540, gold would provide value. However, our base case is that the Fed won’t implement further QE. Our fundamental view on gold is bullish regardless of QE3. Our analysis suggests that gold’s causal driver is global liquidity, of which only one-third is the Fed’s balance sheet. The other two-thirds of liquidity are driven by global government borrowing. We do not believe that government borrowing in nominal terms is about to decline.

Gold support is at $1,530 and $1,525. Resistance is at $1,542 and $1,560.

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