Gold and Silver Gain After Central Banks Launch Helicopters

The markets are roaring today.  The Dow is surging more than 3%, while gold and silver gain nearly 2%.  There is an abundance of news fueling today’s rally.  Most importantly for precious metal investors, central banks prove once again they are willing to provide stimulus to the global financial market.

Last week, I discussed how there was a liquidity crunch taking place, and how investors were forced to sell precious metals to raise US dollars.  Early Wednesday, central banks around the world decided to address the liquidity problem.  Due to the European debt crisis rattling markets, European banks have a near impossible time borrowing US dollars in the wholesale market.  Furthermore, it is more expensive to make dollar loans based on euro assets because the cost of foreign exchange swaps have increased.  In fact, the cost for European banks to fund in US dollars jumped to the highest level since 2008.  In response to this, central banks around the world, led by the Federal Reserve, agreed to lower the cost of emergency dollar funding.  The new interest rate is the dollar overnight index swap rate plus 50 basis points, which represents a half percentage-point cut.  This program will run till at least February 2013.  The Federal Reserve made the decision along with the European Central Bank, Bank of England, Bank of Japan, Bank of Canada, and Swiss National Bank.

Today’s coordinated move by central banks magnifies the willingness of the banks to provide cheap dollars to the world.  The euro jumped to as high as $1.3532, after being flat before the announcement.  It was the highest level for the euro in about two weeks.  In essence, today’s announcement means the Federal Reserve will be bailing out Europe by printing dollars to give to the European Central Bank in exchange for euros.  The move addresses the liquidity problem, but completely ignores the solvency problem of our entire financial system.  Jay Bryson, a global economist at Wells Fargo said, “It doesn’t solve the problem in Europe, but to the extent that European banks are having trouble raising dollar funding, it makes it easier and less costly for these banks to borrow dollars.”

While the reduction in dollar cost borrowing was another bullish sign for precious metals, there is another announcement this morning that deserves attention.  Even though China’s inflation hit a three-year high in July, China appears ready to forget the past. On Wednesday, China cut its bank-reserve requirements for the first time in nearly three years.  The WSJ reports, “The People’s Bank of China, China’s central bank, said Wednesday it will cut the reserve-requirement ratio for banks by half of a percentage point, the first such cut since December 2008.  The cut essentially frees up banks to lend additional money.”  The move is being seen as a policy shift from monetary tightening to monetary easing.  The move is estimated to free up around 390 million yuan ($61 billion) in funds for the banks to lend.

The recent announcements by central banks came at a very convenient time for the market.  Late Tuesday, rating agency Standard & Poor’s announced downgrades on 37 global banks, by applying its new ratings criteria for banks, which were published earlier this month.  Today’s new round of stimulus appears to be saving global banks from the abyss for now.  Meanwhile, gold and silver both continue to challenge short-term resistance at $1,750 and $33, respectively.

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