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Interesting Days Ahead For The Dollar And Gold

December 2, 2009 by  

Interesting Days Ahead For The Dollar And Gold

Almost daily the price of gold is reaching new heights. So where are we headed from here?

To answer this question, we need to recognize that there are still reasons to be cautious, in the near-term, for gold. The market really had gotten overbought, and the correction of late October probably didn’t release much of this pressure.

In addition, the greenback’s fall had gotten to the point where our trading partners were beginning to scream bloody murder. With a growing international consensus forming to abandon the dollar as a reserve currency, even the Obama administration must have been forced to pay it a bit of attention. So, despite the fact that a lower dollar is desirable in Washington (both as a supposed lubricant for the economy and as a payoff to various political constituencies), I wouldn’t doubt that the October respite in the dollar’s decline was orchestrated by official sources.

If so, the current dollar nosedive could lead to some sort of interventioneven mere jawboningthat might breathe some life back into the greenback and send gold tumbling.

And it wouldn’t take much movement in the dollar to knock the snot out of gold, because the yellow metal not only responds inversely to the dollar’s moves, it leverages those moves in the opposite direction. That’s why a very mild rally in the dollar in October led to a much greater decline in gold, on a percentage basis.

The new Kitco Gold Index, featured near the top of their home page, is a great tool for illustrating this effect. For any change in the gold price upwards or downwards, it shows the amount of change that relates to the percentage change in the U.S. dollar index. The balance of the change in gold is due to, as Kitco calls it, “predominant buying” (or “selling”).

This tool also shows how the leverage cuts both ways. On some recent days a fall in the dollar index of around a half of a percent would vault gold up nearly 2 percent.

The bottom line, both in the short and long term, is that the dollar will continue to drive gold, as well as the U.S. stock market. And, as a corollary to this, any positive economic news for the American economy will send the dollar tumbling… and those other two asset classes soaring.

Why? Because, as I’ve noted recently, there is a huge flood of liquidity, in the form of credit, currency and excess bank reserves, overhanging the economy, waiting to be put into effect.

Think of it as the contents of the Pacific Ocean, suspended above us in an enormous balloon. Any sign of sustained economic growthgrowth that can unlock the still-frozen credit marketswill serve as the pin that pricks this balloon.

When that happens, all this newly authorized money that has been hidden behind the scenes will suddenly pop into existence as new dollars and new liquidity. The end result, which the market clearly sees, is that the value of all currently existing dollars will be substantially diluted.

So, at least over the long term, any view of gold’s future must be intimately tied to the prospects for the U.S. dollar.

And, given the trillions in new deficits and debt… the prospects for an unleashing of unprecedented, pent-up liquidity… and the clear intent of the regime in Washington to continue expanding the role and expense of the Federal government, is there anyone who can be bullish on the dollar?

The Past Points To The Future
Assuming, as we clearly must, that the long-term trend for the dollar is down, where can that scenario put gold in terms of price?

The past may help guide us. As I noted in my speech at the recent New
Orleans Investment Conference, gold’s impressive breakout over $1,000 appeared to be very similar to previous rallies in 2005 and 2007. Both of those previous breakouts occurred after significant corrections marked by very similar patterns in their price trend lines and moving averages.

Most importantly, as you can see from the accompanying “analog” chart produced by our good friend Ron Griess of Thechartstore.com, the 2005 and 2007 rallies took the gold price up 75 percent and 57 percent, respectively. In 2005, the rally lasted about 240 trading days, while the run in 2007 was shorter, at about 180 trading days.

If you mark the beginning of all three rallies to the day each broke out of their consolidation triangles, then the current run in gold is about 90 trading days old, from its breakout on Aug. 17.

Again, assuming that the future will at least rhyme with the past, if not repeat it, then gold would have from 90 to 150 trading days left in its current rally. If the rallies are growing shorter, as our two-datapoint trend might indicate, then the rally may be of even shorter duration.

As to the degree of the rally, let’s project that it could take gold from 40 percent to 75 percent higher (again, assuming we see a performance similar to the 2005 and 2007 breakouts). From the Aug. 17 close of $937.30, that would translate to a gold price in the range of $1,312 to $1,640.

For this to happen, however, I’m convinced we would need an associated fall in the dollar. But, given gold’s leverage to the greenback, a fall of only 10 percent to 15 percent in the dollar index would likely yield the types of gains we’re talking about for gold.

So, a fun little exercise in math. Let’s hope it works out. In the meantime, suffice to say that I’m bullish on gold for the next few months, but a bit concerned about volatility along the way.

Brien Lundin

is the editor and publisher of Gold Newsletter, a publication that has ranked among the world's leading precious metals and resource stock advisories since 1971. To learn more about Gold Newsletter, visit www.goldnewsletter.com. Mr. Lundin is also the host of the famed New Orleans Investment Conference, the world's oldest and most respected gold investment event. To learn more, visit www.neworleansconference.com.

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