How Will the Fiscal Cliff Affect Gold and Silver?

The ongoing debates regarding the fiscal cliff raise the question how it will affect precious metals prices. Let’s take a closer look on this issue and potential ramifications passing the fiscal cliff could have on precious metals markets.

It’s still unclear whether the U.S Congress will be able to reach an agreement with President Obama on the austerity plan needed to cut the U.S deficit in the next decade. If an agreement won’t be reached, then the U.S will pass the so called “fiscal cliff”, in which automated budget spending cuts will be implemented along with tax hikes that include not extending the Bush Tax Cuts.

Let’s examine how the potential severe spending cuts and tax increase could affect the prices of gold and silver. For now let’s assume the U.S congress won’t be able to reach an agreement and the U.S will pass the fiscal cliff so that the spending cuts and tax bumps will be set on January 1st, 2013. Let’s break down the potential effect on precious metals:

  1. U.S Economy Could Pull Down: These austerity steps could adversely affect the US economy. This in turn, could lower the demand for U.S securities, and thus depreciate the U.S dollar against other currencies. This projection will span over the next several years and thus could have a slow positive effect on safe haven investments such as gold and silver;
  2. FOMC Introducing Additional Stimulus: One of the main concerns of Bernanke is passing the fiscal cliff which could pull down the U.S economy. This could mean the FOMC will up its ante and introduce additional stimulus to jump-start the economy. If the Fed might decide to extend QE3 (more funds, include additional treasuries to purchase), raise the inflation target, intervene in the foreign exchange market, set a target for long term yields, extend operation twist etc. These plans, however, might have a diminishing effect on the U.S economy and without the fiscal response they are less likely to pull up the U.S economy. Nonetheless, these plans could raise the fear of a devaluation of the USD and raise the demand for bullion.

This analysis shows precious metals could benefit from passing the fiscal cliff, however, the effect could be over time.

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