By: Peter J. Cooper
For the past six months gold has risen in value when the dollar has weakened and vice-versa, while the relationship with the euro has been the reverse. But increasingly precious metals are being regarded as a currency in their own right, and that should mean a decoupling from the dollar and euro as gold is not governed by inflationary central banks.
Certainly the euro’s reputation as a solid currency and a worthy successor to the deutschemark has taken a battering over the summer, as it has become clear that the credit crunch and energy crisis has also taken its toll on the European economy which might even enter recession before the US finally gets there.
The European economies are a heterogeneous bunch with Spain, Ireland and Italy deep in debt and suffering real estate crises while Germany never succumbed to the housing mania. But the downturn in the weaker euro-economies is weighing on the stronger areas, quite apart from producing policy dilemmas at the highest levels, not to say outright disagreements.
In the middle of August some animal spirit seems to have stirred in the European Central Bank and a concerted round of currency intervention conspired to bring the euro down from almost $1.60 to the current $1.47.
Not surprisingly, given the assumed dollar link, gold tumbled in its wake from over $900 to $782 an ounce before rebounding back to the mid-$800s.
It looks as though a line was drawn in the sand at $1.60 for the euro, at least for the time being. Whether that proves to be sustainable is another thing entirely. One major US bank failure is forecast in the next few months while over 100 banks are on the Fed sick list; the housing credit agencies Freddie Mac and Fannie Mae are due for a multi-billion bail-out; and a whole queue of industries from autos to airlines are likely to need assistance, perhaps like the $50bn soft loan to GM to develop an electric car.
All this is going to cost a great many dollars and that means issuing more treasury bonds and inflating the money supply. More money in circulation means a higher rate of inflation and a lower value for the dollar relative to currencies that are not printing money at the same speed. So where does this leave gold?
Nobody can print gold. Its supply is inflated by annual production at no more than a couple of percent a year. Why should gold’s fortune therefore be linked to the relative movements of the dollar and the euro, especially at a time when monetary inflation becomes extreme?
Gold should logically start to move against all currencies, and that may just be starting. Strong buying of physical gold has emerged from India even while the investment market for gold was paralyzed like a rabbit caught in the headlights by the resurgent dollar, while there has been strong investment demand for silver and a rebound from its sudden fall.
There is also a renewed interest in holding gold among US retail investors as shown by the US Mint’s suspension of golden eagle coin sales this month due to unprecedented demand. And now we are heading into the traditionally strongest months of the year for the yellow metal, driven by fundamentals like the religious calendar in India and the buying of jewelry.
Thus it may prove perfectly possible for gold to advance in value this autumn despite a resurgent US dollar, or perhaps we should see this more correctly as a break for independence by the yellow metal which may now cut a path of its own as a quasi-currency, dragging silver along with it.
As soon as gold is reckoned to have broken from the dollar and the euro then the gold market will be seen very differently by investors. There is a crying need for a new favorite investment class as a definitive hedge against inflation.
Demand from Europe and the Far East will really take off under these circumstances, not simply as a hedge against the US dollar but as a means of countering inflation and beating falling stock markets, which look very vulnerable to a major crash this autumn or soon after being overvalued on fundamentals like the profit outlook.
Then gold will achieve a new status as an investment class, something that has been building up very steadily since the start of the bull market in 2000. This will set the stage for the second phase of this gold bull market with prices running quickly above $1,200 with $1,650 as a two-year target. Silver could perform even better as it has since 2000 with almost double gold’s total gain.
The golden opportunity to buy precious metals and associated assets like precious metal stocks is now, as gold and silver are going to be both a currency of choice and surging asset class from hereon.
Peter J. Cooper
AFLAM DLJO
