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Tuesday, November 3, 2009

Why the Rise in the Gold Price is Different this Time.

For over more than 18 months we have watched the gold price churn below $1,000 and in the process forming three tops, before breaking out to above $1,050 in early October 2009. Why will it not fall back to well below $1,000 and possibly as far as $850 this time?

Technical Picture
Peter has given a great deal of detail below, in this issue and has warned, precisely, of the various support and resistance levels to watch out for. This information is critical for you, the subscriber, so as to help in your buying and selling considerations.

The U.S. $
For many months now too, while traders played the gold price against the U.S. $ the gold price has been precise in its inverse correlation to the $. We believe that this has mistakenly led commentators to place far too much emphasis on the $, as the inverse measure of gold.

We say this because the moves occurred at a time when many facets of the gold market were absent from the gold market, such as investment demand, low jewelry demand and central bank demand. Traders held sway over the gold price and it is they that decided that the moves of the $: € decided the price of gold. This lacked a reasonable basis to it. Why should the gold price be tied to the €? Such a relationship implies that the $ in isolation, is the most important factor in the gold market. We counter that and say, yes COMEX is a U.S. market and such traders do have enormous pricing power, but when the full force of all sides of the gold market come into play, COMEX diminishes in importance, just as the waves of the sea are of less important than tides are, to where the sea will climb on the shoreline.

Yes, the state of the $ is important in pricing gold and it is the ‘hub’ of the currency world, but to gaze at it alone is to ignore the much bigger world of gold in its entirety, acting together in synthesis, in deciding the gold price.

This is amply demonstrated by the fact that the U.S. $ is sitting not far off the same place, against the €, as it was when gold was just below $1,000. We now foresee a larger de-coupling from the $ by gold, as we move forward. Yes, the waves of the $ will ebb and flow and continue to cause traders to move the gold price against the $ as before, but the tide of investment demand and other factors in the gold market will flow and dominate these moves over time.

Why Different this Time?

As we wrote last week, while the facts of the article in the Independent [British] newspaper, informing the market that France, China, Russia and select Persian Gulf oil producers were going to price oil in a ‘new’ currency were denied, the market is convinced that this will happen in time, even if it takes another decade. The reaction in the gold market was to bring in new investment demand via bullion itself, to prompt heavier central bank selling, to slow scrap sales and to cause traders to add some more gold to their holdings.

On top of the consolidation phase the gold price has been going through over the last 18+ months, this was a breakout pointing to an end of that phase. Now it sits on top of the $1,000 level, which forms a huge support to the price.

Watershed for the Monetary System

This showed a tipping of the see-saw against confidence in the monetary system. It was due to the realization that very little is going to be done to effectively reform the currency world and bring back stability to these markets. More than that, it was the realization that world governments just don’t have the real political will to ensure a stable world currency system. There are just too many conflicts of interest for them to do so.

Meanwhile, the system decays on a broad front. The very fact that the hub of the currency world, the U.S. $ is losing favor so quickly sends out a bigger warning to investors and the global economy. Just take a look at what central banks have been doing in the last few months.

Foreign currency holdings grew by $413 billion last quarter, the most since at least 2003, to $7.3 trillion. Nations that report currency breakdowns put 63% of this new money into the € and Yen in April, May, and June. That’s the highest percentage in any quarter with more than an $80 billion increase. Until now China has expressed concern about the behavior of the $ alongside other nations but were hesitant to act like this, because of the damage it would do to the exchange rate of the $. Now the realization of the fact that the $ will weaken is prompting action.

Imagine if oil was priced in a ‘basket of currencies, that diversification would be unstoppable and the $ would face a major crisis. Now, it is only a question of when.

Some commentators are saying gold is rising because of inflation fears, but inflation is not likely to accelerate until the global recovery is strong and deflation has evaporated. And yet gold is rising.

What concerns foreign holders of the $ is its exchange rate. This means far more than U.S. goods getting cheaper and European goods getting more expensive, it means the future worth of the $ in terms of all other currencies.

e.g. If Europe sells goods to China, it prices them in the U.S. $. The buyer and seller need to price those goods in a way that allows them to budget correctly and be able to pay correctly and make their profit on the deal. If the U.S. $ [which has nothing to do with the underlying transaction] falls, then Europe gets less Euros to pay the supplier. This gives a great incentive not to use the $ in these transactions. If that trend takes off, then the $ will be used less, globally, and cause an excess of dollars to float around the system, taking it even lower. The dollar’s 37% share of new reserves fell from about a 63% average since 1999.

The point for gold is that even central banks are wary of the U.S. $ and consequently expect uncertainty to spread like the plague through other dependent currencies, as they try to keep their exports competitive in the world market. Despite it being money in earlier times only, gold remains the only money that can be exchanged when confidence is lost and still hold its value. This reality is rapidly rushing at us and is why gold is rising in price.

Need to Quantify?

Among financial professionals the need to quantify, to measure, to relate is insatiable. Look back across the last few years of the gold market. Gold was thought to move against oil. This was dropped when the facts showed differently. Gold was thought to be anti-inflationary. While it has these properties, the price is rising in the absence of inflation at the moment. Growth or the lack thereof was tied to gold’s performance, but when deflation hit and gold held its price that was dropped too. In general the gold price was thought to be a tied into something in the U.S. alone. Is this because of the myopic view of U.S. markets or is it really a reality? Clearly, Europe and the rest of the world are involved in the gold market too. In fact 90% of the world’s bullion is dealt in London!

So we have to counter this hunger to quantify and recognize that there are a huge number of times in our lives and our markets when reason and measurability are absent. The gold market is reflecting one of those times right now. When emotions creep in, many such professionals go into denial, until they can find something else to measure that emotion against. By that time the damage has often been done. The point of the Independent newspaper report was that it precipitated pent-up emotion against the U.S. $. Now the $ will be seen in that negative light, not as a strong currency dominating world currencies. It is moving to pariah status if it keeps on this road. It is too late for political ‘spin’.

When the Titanic sank, there was a point in time, when the ‘unsinkable’ ship in the passenger’s minds, changed to a sinking ship. The breakout in the gold price was just such a point in time.

yen dollar The Price of the $?

What has happened imperceptibly is a change in measuring value. Until now, everything was measured in the U.S. $. It was the ultimate measure of value for over half a century. With uncertainty, led by global central banks, other measures of value are now needed. Where can they be found, amongst other currencies?

The ailments hitting the U.S. $ can affect other currencies, all of which are controlled ultimately by their central banks and governments. If the U.S. Administration can’t hold financial confidence why should any other currency do so? The road down for the $ will eventually lead to something that cannot be debauched by governments. The actions of the Chinese and Russian central banks, tells us that they trust a ‘basket of currencies’ [which minimize the impact of any individual government] and, to some extent, gold.

For years now we have said a day will come when the gold price won’t be say $1,000, but that $1,000 will be worth an ounce of gold. We’ve arrived.