Three Criteria for EU QE and Why It Would Be Explosive for Gold

Price moves during the course of the last week would suggest that the gold market has been largely at the mercy of news flow out of the Eurozone.

Gold prices jumped on the European Central Bank's announcement of policy easing yesterday, but fell back after Mario Draghi, the president of the ECB, said it would not act as a lender of last resort.

According to a note from UBS, while this announcement came as a blow to hopes for a bout of European quantitative easing, expectations of a positive outcome from the EU summit remain high.

"For gold," the bank writes, "a positive outcome will buoy prices, in as much as it would support risk sentiment. The ECB's accommodative policy also helps. But the most crucial point, which would have explosive implications for gold, is the potential for quantitative easing (QE)."

The group says there are three pre-conditions the need to be met for the ECB to employ this monetary tool.

"First, national governments have to deliver on their fiscal efforts...Second, the ECB has to be convinced that substantial progress has been made towards a fiscal agreement. It does not have to be full fiscal integration so this requirement could well be achieved as early as today. Finally, the ECB will have to exhaust all conventional tools - this means that policy rates would need to be brought down to what is deemed to be a floor, before QE can be considered."

With regard to the first criterion, as UBS points out, implementation risk here remains very high. There are clearly many actors on the stage and each one has very specific mandates from their respective populations.

Speaking on Mineweb.com's Gold Weekly Podcast earlier this week, Hinde Capital CEO, Ben Davies, agrees that this is an easy task to pull off.

"You can't have monetary union without fiscal union. It doesn't work we've seen that but there is a sequencing event here and it's interesting that the ECB president, Draghi - he spoke last Friday and it was a very important speech because he talked about, he inferred sequencing. If they get a treaty change we move towards fiscal integration then maybe we will implement some form of monetization."

And while, as he points out that only about 5% of the MEPs were actually in the European parliament to hear that speech, he remains hopeful that there is a sequence of events that looks like it may be beginning to unfold.

"I am hopeful that they will come up with the beginnings of fiscal integration but this is only beginning because it is going to take a lot of time for this process to pass."

Concerning the third criterion, UBS's expectation is that the ECB will ease monetary policy to 0.5% by the end of the Q112—which it now views as the floor rate.

Given that there is no way to know yet how all of these events will unfold, significant volatility is likely to remain in the system for some time but, as UBS points out," Should all three conditions for ECB QE be fulfilled in the coming months, it would be very positive for gold."

Geoff Candy, Mineweb