We knew it would have to happen sooner or later. With the gold price rising in nearly parabolic fashion since late August… and with speculators itching to pocket their rich gains at the first excuse… any significant rebound in the dollar was likely to trigger a significant correction.
That trigger was pulled by a surprisingly positive November payrolls report (which raised the possibility of U.S. rate hikes) and by credit downgrades for Greece, Portugal and Spain (which lowered the chances for rate hikes in Europe). These developments, in combination with credit troubles in Dubai, were enough to halt the slide in the U.S. dollar.
It’s not that the prospects for the dollar are great. It’s just that the prospects for the rest of the world were suddenly judged much worse in comparison.
The result, as I write this, has been a fall of about 10 percent from gold’s high-water mark in the rally.
The return of risk aversion to the global markets is certainly not bullish for gold. That may sound strange to those steeped in the lore of gold as the safest of safe havens. But in this day and age, when massive speculative positions are built like houses of cards on foundations of cheap money and margin, reversals of such trades mean that accounts must be settled in currency. And that currency is usually the U.S. dollar.
Thus, exiting speculations means a search for liquidity. And gold, as the ultimate source of liquidity, is often the piggy bank that is robbed when speculators need cash.
Even in these situations, the metal can serve as a financial life preserver—it didn’t do nearly as badly as other assets during the financial crisis of 2008. But there’s no denying that a global stampede to liquidity seriously hurts gold and gold investors.
The current situation has not devolved into a stampede just yet. But you can bet that there will be more credit-agency downgrades of U.S. states, and countries, as well as other assorted crises, in the days ahead. So caution is advised.
With that said there is certainly no reason to be bullish on the dollar for the long term. If the trillions in debt and new currency created over the past year weren’t already enough to dissuade one from relying on the future value of the greenback, President Obama’s decision to “spend our way out of this recession” by applying funds from the Troubled Assets Relief Program (TARP) to another round of supposed stimulus only makes the upcoming monetary inflation more certain and menacing.
This scenario is, obviously, very bullish for gold. But an even more positive outcome, like a significant economic rebound, would help gold’s cause by unleashing pent-up excess banking reserves that are currently overhanging the economy. So, over the longer term, gold wins either way.
But what about the short term? On an economic basis, as I noted, I expect more bad news from overseas. But I also expect the bloom to come off of the rose in the U.S. as well. For example, the November payrolls report that everyone went crazy over could be reversed as soon as the next report is released.
As John Williams of Shadow Government Statistics (shadowstats.com) notes, the November report was victimized by highly variable seasonal adjustments, which are themselves the result of the wildly volatile economic environment of last year. He expects the positive November surprise to be reversed, with an equally surprising upturn in the unemployment rate, with December’s reporting.
As John puts it, “The short-term reporting of payroll data is misleading—virtually worthless—at the moment.”
As far as gold itself, we were waiting for, even hoping for, some break in the metal’s dizzying ascent. But as Mencken warned, we should’ve been careful what we asked for. We wanted a healthy little correction or brief respite. What we got was a pretty vicious sell-off.
Still, this should be good for the market. The speculators were overloaded on the long end, and the commercials were oversold on the short end. Just as the speculators jumped ship, we should begin to see short covering from the commercials come in to support the market.
More importantly, we should also see physical demand return in force upon the first signs that the price has bottomed.
This brings up the argument that, until recently, was raging amongst gold bugs and bulls. Some maintained that it was physical demand driving gold higher, while others held that a weakening dollar was behind the big rally.
In truth, it was a bit of both—and for gold to continue its rally, we will need both factors to contribute going forward. The good news is that both seem likely to remain in effect for some time.
Physical demand will remain robust as the global economy recovers and grows and, as I’ve noted, there is little reason to expect sustained strength in the U.S. greenback.
A Buying Opportunity
If this rally was to play out like the similar breakouts in 2005 and 2007, I was forecasting a gold price in the $1,350-$1,500 range by March or April. Yet gold’s recent trajectory had left me wondering if the metal was going to hit that mark much sooner… or overshoot it on the upside.
As it turns out, the sell-off put a much-needed squiggle in the price trend, and leaves gold back on track to hit our previous targets.
So is this a buying opportunity? I think so. We may see further weakness if there are further credit downgrades overseas, or if some other potential crisis frightens the market and sends investors running for cash. And the thin holiday markets can bring nerve wracking volatility—to both the upside and downside.
But when it’s all said and done I expect short-covering and physical demand to stabilize the gold price and set us up for a renewed ascent this year.