Gold and the
Dollar
The following is an extract from
commentary that was posted at www.speculative-investor.com on 2nd December.
Note that we advised subscribers to sell trading positions in gold stocks
when the gold price broke its short-term up-trend on Oct-09. We have just
recently (the past 2 weeks) suggested re-establishing trading positions
in a few gold and silver stocks in anticipation of what will probably turn
out to be an oversold bounce, but has the potential to be the start of
something more substantial.
In last week's commentary we said that
a) the odds favoured the gold price moving sideways for the next 3-4 months,
and b) in the very short-term (the coming few weeks) a bounce in gold and
gold stocks would likely occur in parallel with a pullback in the Dollar.
Our main reason for not expecting a large upward move in the gold price
over the next few months stems from our currency market view. As bearish
as we are on the Dollar's long-term prospects, a number of factors are
coming together to create a temporarily-bullish environment for the Dollar.
These factors are briefly outlined below.
Firstly, the Sep-11 disaster has altered
capital flows in a way that benefits the Dollar in the short-term. The
amount of money flowing into the US has certainly increased as a result
of the payment of insurance claims. Also, the massive clean-up/rebuilding
operation in New York, the provision of additional security throughout
the US, and the war effort are adding to the demand for dollars. At the
same time we suspect that US corporations will be putting some of their
overseas expansion plans on hold until the risk of further terrorist attacks
against America is perceived to have lessened.
Secondly the Bank of Japan, based on
some absurd belief that a weaker Yen will help extricate Japan from its
economic woes, has been selling Yen and buying Dollars. The Japanese appear
to be determined to prevent natural market forces from pushing the Yen
higher against the Dollar. It has now been suggested that the BOJ will
even go so far as to monetise (purchase using currency created out of thin
air) foreign government debt (US Treasuries, no doubt) in its efforts to
weaken the Yen.
Thirdly and perhaps most importantly,
the conversion of all the European national currencies into euro notes
and coins begins on 1st January 2002 and must be complete by 28th February
2002. Euro-bulls no doubt believe that once the euro has a physical presence
its value relative to the Dollar will rise, but that is not how these things
usually go. Not everyone who owns German Marks and French Francs will be
happy to exchange them for euros. In fact, some of the existing holders
of Marks and Francs will prefer the perceived safety of an international
currency that has been around for longer than 15 minutes. The forced conversion
to euros may therefore give the demand for US Dollars a substantial boost
during the first quarter of next year. Note that this is potentially one
time when a weak euro will not go hand-in-hand with a weak gold
price since a flight from the euro would probably boost both Dollar
demand and gold demand.
The above factors might be sufficient
to give the Dollar's foreign exchange value an upward bias over the next
few months. Longer-term, however, the Dollar is in big trouble for two
main reasons. Firstly, the real returns on US assets and debt have been
extremely low for much of this year and are likely to remain low for at
least the next 12 months. This is a huge problem for a country that relies
on foreigners making enough new investments each month to offset a $30B/month
current account deficit. Secondly, the explosive growth in the supply of
US Dollars is eventually going to take its toll on the Dollar's relative
value.
If the Dollar's short-term positives
are able to overwhelm the longer-term negatives, the Dollar's price action
will remain bullish. This means that the Dollar Index will hold above support
during the current pullback.
Below is a chart of the Dollar Index.
Notice that the 50-day moving-average (shown in blue) acted as support
as the Dollar trended higher from mid-February through to mid-July. During
this period the 50-DMA was tested on a few occasions but was never breached
on a closing basis until the major decline began in July. The Dollar Index
moved back above its 50-DMA during the first half of October and, in early-November,
dropped back to the 50-DMA before rallying anew. The pullback that began
about one week ago now appears to be setting up another test of this moving
average. As such, the first sign that something is wrong (that the short-term
bullish argument for the Dollar is faltering) would be a daily close below
the 50-DMA.
Getting back to gold, our view that
gold will trade sideways (oscillate within a trading range) over the next
few months is based on our view that the Dollar's current pullback will
be followed by a Dollar rally to a post-September recovery high during
the first quarter of next year. It would be highly unlikely for the gold
price to experience a strong rally in parallel with a rallying Dollar.
At the same time, the risk of a sustained move below $270 is very small
(if they haven't done so already, Bob Prechter and his team will eventually
come to realise that THE major bottom for gold occurred in August-1999
when the gold price dropped to the low-250s).
If our current expectations for the
gold price over the coming 3-4 months prove to be wrong it will most likely
be because we are not bullish enough. The risks are predominantly on the
upside (short-term positive influences may not be sufficient to overwhelm
the Dollar's long-term dismal fundamentals in which case the gold price
will surge sooner rather than later).
Regular financial market forecasts
and
analyses are provided at our web site:
http://www.speculative-investor.com/new/index.html
One-month free trial available.
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