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With gold ratcheting up to new
highs in the $800’s, we may easily see $850 and even $900 very soon. Oil is
going out of sight, but there are some good fundamental reasons – like Yemeni
pipelines blowing up, North Sea shutdowns, the ever present new manifestation
of Mid East turmoil – and a Pakistani political crisis as they impose state
of emergency measures. Of course with all this profit in the gold complex
right now, some profit taking and consolidation is quite possible
before $900.
Nevertheless, our question
here is – is gold carving out new high prices that are going to stay with us
into 08, or even longer, and maybe find its prices in staying over $1000 in
08? We surmise this is likely, as the USD carves out a permanent new low
range well below 80 on the US dollar index, its former low.
USD driving gold
The real driver of gold is the
ongoing fall of the USD, which so far has not seen a bottom after it fell
below 80 on the USDX. When the USD fell below 80 on the USDX recently and
stayed there, that was a new low range, as 80 has been a low for many years.
Formerly, whenever the USD dropped to 80, it was supported. Our trade
partners’ central banks would intervene. Even if it did drop below 80,
it was a blip. Usually, when the USD hit that level, it signaled a short term
USD bull, and the USD would get back up to 84, 85, or higher.
During those times, 700’s was
pretty much a high range for gold recently. But gold’s new record highs
(nominally, not inflation adjusted) reflect evidence that the USD is finally
turning to a new low range on the USDX (basket of currencies heavily Euro
weighted). Right now, it’s a question of whether the USD will carve out a
range in the mid 70’s, or can it even break into the 60’s?
Major central banks have
recently stated they are moving their minimum USD exchange rate tolerance
lower. Up to recently, the ECB stated 1.40 USD to the Euro would cause
intervention. Now that has changed to 1.50, according to some of their
comments. Up to now, the BOJ would intervene to support the USD if it
threatened to hit 110 Yen to the USD. That might still happen, but they
recently made comments that the new defense level could be 100 Yen.
Those are two major changes
about USD exchange rate policy since recent years. Those statements, and
China’s noises about the USD losing its world reserve currency status, have
made currency markets realize new lower ranges for the USD below 80 on the
USDX are likely permanent. The only question just now is where is the new low
range? The USD is presently at 75.31, gold at an amazing $840.
There are a lot of reasons for
the USD to weaken and find a significantly new low range right now. Probably
the most significant is that our trade partner central banks have apparently
decided to let the USD find new lows, whereas previously they defended the
USD at 80. Of course we all know there are many good reasons for the USD to
weaken, like a weakening US economy, huge trade deficits and so on. But, up
to now, our trade partners were willing to support the USD despite that.
If central banks have indeed
decided to let the USD find a new low range, then gold will reflect that. In
fact, gold will outrun the actual USD fall (increase disproportionately)
because central banks new lower USD policy is a major change from recent
years. And of course, when gold carves new highs like this, and the USD new
lows, speculators are all over gold, and a weak dollar.
The question becomes, then,
will gold’s new highs, and the USD new lows remain with us, or will this
merely be a recent spike, and a significant correction come about, and gold
return to the low 700’s for example?
Or are we now next looking at
gold prices over $1000, and in two years you will kick yourself for having to
spend thousands of dollars an ounce to get some? “Darn, I could have bought
gold at $800 bucks last year, and now its $1600!” – etc.
A permanent new high range for
gold?
So we discuss the question of
permanency of new gold prices levels – and are we next looking at over $1000
gold by January, and will the $800s be a new floor?
First of all, if gold is to
remain at these new high levels ($800 and more) there have to be good
fundamental reasons that stay with us. The foremost of these would be that
the USD is now permanently in a new low range. (below 80 on the USDX and
going lower for years to come).
I remember Paul Van Eden
discussing gold and the USD several years ago, and he repeatedly stated
something like ‘it’s all about the USD, as far as gold prices.’
I agree with that view. We
hear lots of discussion about Mid East turmoil boosting gold (true), oil
prices boosting gold (true), wars, and various reasons for flight to safety.
But these cases are usually short term events, and when the chaos subsides,
gold falls back to whatever major trend it began in. Gold’s major trend has
been grinding higher and higher since 02. The USD grinding lower and
lower, but it did have a floor at 80 on the USDX for many years due to trade
partner intervention.
There is such a huge USD
footprint on the world economy that any movement in the USD affects gold
prices more than anything else.
So, since the USD appears now
to have permanently broken below 80 on the USDX, we definitely have a major
change in world currencies and gold. In fact, as other central banks continue
to raise rates to fight inflation, or find it very hard to ease because of
inflation, and then the US must ease rates to deal with our various economic
problems, and a very serious credit crisis – it is easy to make a case the
USD has indeed carved out a permanent new lower range below 80 on the USDX,
now in the mid 70’s and still falling.
All of this means a weakening
US interest rate premium to other currencies, a lower USD, and probably a new
high range for gold that will stay with us. These are the long term trends
supporting gold.
Now, a comment on the weight
of the USD to gold, and or, gold to other major currencies. Gold is a central
bank reserve asset. Central banks also hold other currencies as reserve
assets. They can then use these reserve assets to support the value of their
currencies.
Since gold is a reserve asset,
unlike other commodities, its value is primarily driven as a comparison of
the total gold reserves outstanding to the total of any one currency
outstanding. In other words, since the USD is so huge worldwide (so much out
there, and a primary world reserve currency) gold’s’ price is primarily
driven by what the USD does. Gold is not primarily driven by varying yearly jewelry
demand in India or Asia for example.
Gold is not primarily driven
by oil prices. Both Jewelry and oil do significantly affect gold, but they
are not primary drivers. What is a primary driver is the very roughly 100,000
tons of gold held for bank reserves, or safety by the public as money,
compared to what the currencies do.
A fluctuation of 400 or 500
tons in gold demand in a year is a drop in the bucket compared to 100,000
tons outstanding. (I know there are more than 100,000 tons but I’m just using
that as an example). Additionally, a 500 ton increase in speculative gold
demand in a year is quite significant, but that component of gold demand is
here today and gone tomorrow, and mostly just adds volatility. Gold ETFs are
growing tremendously this year in tonnage.
And, even in the case of that
gold ETF growth, much of it is not just speculation, but is due to flight to
safety – protecting money from inflation, and a falling USD for example.
Gold is in a long term bull
market vs the USD, and is going to go much higher in coming years. The
political chaos, high oil prices, and other gold bullish factors are merely
adding fuel to the fire. So is renewed speculative interest and ETF growth,
but that component is very flighty.
Of course, gold can correct significantly
if there is a serious world stock sell off, as this has happened numerous
times this year. Nevertheless, apart from a long term world market selloff
that does not recover, I expect gold to get over $1000 in 08, and probably
hold onto those gains. The primary reason is a new lower USD range, yet to be
determined, that will likely stay with us going into 08. It is key that
central banks appear to have decided to let that happen.
We have been discussing these
issues in our PrudentSquirrel newsletter recently. We have been able to
anticipate the 4 major market sell offs this year by up to two days.
Subscribers also get mid week email market alerts, and they say that feature
is greatly appreciated. You might take a look at our alerts link on the main
page to see what kind of topics they covered.
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