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Running With The Bulls: Gold Bugs And Stock Bulls Find Themselves On The Same Team—Pulling Against The Dollar

October 21, 2009 by  

Running With The Bulls: Gold Bugs And Stock Bulls Find Themselves On The Same Team—Pulling Against The Dollar

Gold’s meteoric rise over $1,000 left even the most ardent gold bulls reeling from shock and awe. No matter what their bullish expectations may have been beforehand, few market watchers could honestly say they expected such a powerful run.

They weren’t alone. Investors and analysts were similarly surprised by the power and persistence of the rally in the broad U.S. equity market, and were left grasping for excuses.

The common denominator behind both bull moves: a declining dollar.

Bucking the Trend
Gold and stocks aren’t known as correlated asset classes, to be sure. So their almost perfectly choreographed moves in opposition to the dollar meant that analysts had to explain not only their individual moves, but why they were moving in unison.

Of course, it wasn’t too difficult to connect the stock and gold moves to the weakening dollar. But from there, most supposed experts were left scrambling.

They mentioned a growing dollar carry trade, wherein extremely low interest rates in the U.S. prompt investors to borrow dollars to fund riskier and higher yielding investments elsewhere.

This trade has, indeed, grown. And it will continue to have an impact, as long as the Federal Reserve Open Market Committee’s statements keep noting that “economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

If dollar interest rates are going to be low for the foreseeable future, why wouldn’t you arbitrage those low rates against higher yields elsewhere?

Another excuse put forth for dollar weakness has been the comparatively stronger economic growth rates in China and the rest of Asia. It seems obvious that Asia is far ahead of the West in the economic recovery, and this relative strength has been attracting capital to the dollar’s detriment.

But the columnists and talking heads on CNBC missed some of the most compelling reasons for the dollar’s swoon:

  • The surprisingly broad push for a new global reserve currency to replace the dollar. China, Russia, Brazil, France and other nations have joined an international chorus calling for a new global reserve currency regime, one most likely based on a revamped International Monetary Fund (IMF) special drawing right (SDR).

The calls for talks on this issue have come so frequently, and the silence from the Obama administration has been so obvious, that what once seemed little more than bluff and bluster now appears to be the advance signs of an inevitable abdication of the dollar’s reign as the king of currencies.

I’ve covered this frightening development in recent columns so you know that if President Obama allows this to occur I’ll view it as one of the greatest foreign policy failures in American history. And the fact that the current administration doesn’t view it as such is what truly scares me.

  • The socialization of the American economy. From bailouts to nationalized health care, from more steeply progressive tax rates to the assumption that government can dictate private sector compensation…and the myriad other assaults on capitalism and individual liberty now coming out of Washington, it’s obvious that the America of tomorrow will no longer resemble the dream of our founding fathers.

This concerns not only freedom-loving Americans, but also anyone anywhere in the world with assets in the U.S. When foundational principles are ignored as a matter of political expediency, when the rule of law offers protection only to favored classes or industries, then capital will flee to regimes that offer greater safety and certainty.

This is, in fact, a big factor behind the diminishing role of the U.S economy, and the decreasing relative value of the American dollar.

  • The massive issuance of U.S. dollar debt and currency. I don’t want to belabor the point, but the world has been flooded with liquidity via the creation of unprecedented levels of new debt and currency.

The U.S. hasn’t been the only violator in this regard—only the most egregious.

Some argue that the Federal Reserve, having created much of the new liquidity with the figurative stroke of a pen, can mop it all up just as easily. They ignore the fact that if the Fed was so prescient and powerful it would have never been faced with having to create all that liquidity in the first place.

The Fed is so fearful of deflation, and has become so politicized, that it will almost assuredly overshoot the mark and leave its foot on the monetary gas pedal too long.

The bottom line is that the supply of fiat currency in the world at large has risen precipitously, but to a significantly greater degree in the U.S. While this will translate to higher asset prices generally, it will also translate to a lower relative value of the U.S. dollar.

The writing is on the wall, and investors know it.

A Battle Royale
In the meantime, the bulls and the bears have drawn the battle lines over gold and amassed on both sides what may be the most powerful forces we’ve seen for years.

Consider that the Large Commercial Net Short position in gold has risen to record levels, but on an absolute basis and as a percentage of total open interest. On the other side of the bet the speculative long position has also soared.

As long-time readers know, the large commercials are most often correct in their bets on gold. The reasons for this are two-fold: 1) Because they are so intimately involved in the gold market they understand the underlying forces much better, and 2) because they are typically hedgers who reflexively short gold in a rising price environment, their increasingly larger selling tends to create a self-fulfilling prophecy in lower gold prices.

So, again, when they pile on historically large short positions, gold usually heads south. However—and this is an important distinction—when they are wrong, they are wrong in a very big way.

As I noted last month, a prime example of this came in late 2005, when the large commercials were forced to cover their bets against gold en masse…with the result being a leap in the gold price from $450 to $700 over the coming months.

So the current situation is crucial. If the large commercials are forced to cover, they could send the price skyrocketing.

If the speculative longs are forced to sell out, gold could crater.

Ironically, some of the pressure has been let off by gold’s recent retreat below $1,000. The Commitment of Traders (COT) report for the week of gold’s highs shows that the larger commercials had added even more to their short positions, establishing a new record of 287,610 contracts net short.

However, this huge cumulative short position also acts as a cushion on any price declines. Undoubtedly, as the gold price fell from the recent heights, commercials began covering some of those short positions, helping to prevent further declines.

The physical gold market has also entered into this battle. Here we see a number of new factors coming into play…

First off, we saw the announcement by Barrick Gold that it had—finally, after a $750/ounce rise in gold from 2001—decided to buy back all of its remaining gold hedges.

Whether you think this announcement is bullish or bearish depends on your position in the market…and whether you’re a “glass-half-full” or “half-empty” sort of person.

In other words, once Barrick bought back all of its hedges (and it was rumored that they had already begun doing so in the preceding weeks), then that potential bullish factor would be removed. That’s the glass-half-empty view.

The glass-half-full view holds that Barrick’s upcoming buying will only add more pressure to an already drum-tight gold market.

Not long after Barrick’s announcement, we heard from the International Monetary Fund (IMF) that it was ready to begin the sale of 403 tonnes of gold. This didn’t have the bearish effect that similar announcements have had in the past when this issue has been trotted out to dampen gold price rallies.

It didn’t scare the market much this time because the sale would either come under the umbrella of the Central Bank Gold Agreement (where central bank sales had already slowed to a trickle), or the entire amount would be taken up by China or another central bank. The latter event would be net bullish for gold, by implication more than direct effect.

And finally, we’ve seen surprisingly strong physical demand from Asia, particularly India, despite the rising gold price. The reason? Festivals in India and government programs encouraging gold buying in China helped boost demand, and the weakening dollar meant that gold’s price rise was mitigated in local currencies.

So we can expect that any significant decline in gold, especially if it’s not accompanied by dollar strength of the same degree, will be met by increasingly large physical demand from Asia.

A Pressure Cooker About To Blow
So, the battle lines have been drawn, and it seems the gold price is destined to break strongly one way or the other.

Technically, the extensive consolidation pattern traced out by gold argues for a break to the upside. More fundamentally, the towering net short position of the large commercials seems to favor a correction, although the recent decline below $1,000 may have alleviated some of that pressure.

Regardless of the outcome, it seems safe to say that this rally has already demonstrated greater strength and resilience than anyone ever expected. Even if gold corrects, the price has spent enough time well above $1,000—setting new daily close price records in the process—to make this an important and confirming move.

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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  • DaveH

    Tax Freedom Day. Expect it to be much later in the year soon.
    http://en.wikipedia.org/wiki/Tax_Freedom_Day

    • libertytrain

      One thing to be remember re any Wikipedia link is that all the information is not necessarily accurate since anyone can adjust the information – am not saying this link is in error, just that one needs to be aware that Wikipedia is not necessarily/always a reliable source.

      • DaveH

        No, but it’s a good starting point.

  • DaveH

    Very good article Brien.

  • http://www.chandostransport@eastlink.ca Graeme B

    One has to remember that most of the damage done to the US$ has happened over the last 8 years with a smaller effect this past 9 months. If you were lending money to a debtor such as is the case with US treasury, I’m sure you would want to trade in something more stable. But to blame this on the Obama Administration is both falacious and duplitious. The damage in the bailouts was completed last fall. And to now see the obscene bonuses being paid to the perpetrators of the meltdown is a total disgrace. When the world adopts a new standard for trading, the US$ will drop like a stone. The house of plastic cards will crumble. This should happen by next October 2010.
    Obama has no control over this anymore than the Fed does. The whole world will suffer and the blame will lie with profligate spending of previous administrations, all non-tax and spend GOP’s. When this new currency becomes the standard, all currencies will become worthless, with the whole system starting all over again. What you have in the bank will become like penny stocks, wallpaper. Buy gold and land.

    • s c

      When you return to your home planet, kindly tell everyone there that Earth never needed any ET-styled ‘advisors.’ Aside from the fact that you are a dyed-in-the-wool apologist for a saul alinsky puppet, you have brainwashed yourself into believing that neither the prez nor the Fed have any power to affect the economy. In the real world, that’s what is known as terminal “DUH.”
      Your second paragraph contradicts the first. You sound like one of the many “eight years of Bush’ but ‘I’m a loyal conservative’ parrots who monitor this web site. You CAN’T have it both ways. Anybody who apologizes for comrade obama OR the Fed is no conservative. You need to re-read that playbook, and then hire a proofreader.
      You might as well say “keep all your money in dollars” and “invest in gold” at the same time. Hmmm hmmm hmmm! Back to your home planet! Be gone!

      • eyeswideopen

        S.C. who runs the Fed? Oh, Ben Bernake? A Republican? NO, say it aint so!!! Who made the decisions prior to Obama? Henry Paulson, a Republican? No, say it aint so…. You are a bunch of hypocrites, who can’t admit that your party (my ex party) did much damage to this country. I must say, not balancing the budget was a smooth move on the repubs part. Cutting taxes while starting two wars, was the most brazenly stupid thing to do. History tells us that is not a fiscally responsible action. I suppose you would have rather had us have a depression, rather than a recession? Sounds about right.

        • DaveH

          hypocrite:
          a person who acts in contradiction to his or her stated beliefs or feelings.

          Here you are bad-mouthing the Republicans for their profligate spending (true), but you often praise and support the Liberals who are championing (you guessed it) profligate spending.

    • DaveH

      Never mind that $2 trillion has been added to the National Debt since Obama took Office. Of course it is not all his fault. A lion’s share of the blame goes to the Congressional Democrats who don’t see a spending bill they don’t like.
      It will get much worse if the Democrats pass their takeover of the healthcare industry. And then their Global Warming Bill (Cap and Trade).

      • s c

        You’re right, DaveH. However, it is utterly pointless to try and keep comrade obama and the many varieties of libs seprated. What party got that yahoo into the white house?
        If he’s making democrats look bad, that’s tough. If they’re making him look bad, that’s tough. We do not have time to sort this wacko from that wacko group, especially when BOTH are frantically trying to destroy America.
        If we had a choice in the matter, I’d be glad to have some REAL democrats around. However, REAL democrats are extinct. As far as I’m concerned, people who claim to be democrats deserve all the grief America can throw at them [RINOs, too, but I'm not talking about those losers].

  • James

    Right on DaveH!!

    • James

      Notice to the editor, this ‘James’ comment here is not mine. There are two James’ here?

  • CabotAR

    Gold just dropped to 75.07, close to 74 on the world currency market, down from 81 just a few weeks ago. When the dollar hits the depression level then all hell is going to break out.

    Nowadays Americans are the same type of Americans seen in the Great Depression. They will lash out,and it will be at politicians & federal tyranny.

    Just read a great new, underground novel out that’s insightful & so real. Americans, in a small town, stand up to federal tyranny & end up starting the 2nd American Revolution. It’s powerful & I strongly recommend everyone read it. I gave 2 to friends, that’s how insightful it is…Just read it & see what’s coming nxt for all of us.

    • Kellie

      And the NAME of this great novel is…..?!?!!? sheesh

  • s c

    It seems like everyone on the face of the planet – except our elected non-leaders in Washington – knows that the Chinese government has told their people to buy SILVER and GOLD. Here, where leadership, ethics and tin-plated reputations are always FOR SALE, it’s ‘business-as-usual.’
    That is, everything is beautiful. There is no cause for alarm. Our glorious leader will protect us. Next, I suppose he’ll re-hash FDR’s words and say ‘we have nothing to fear but fear itself.’ The ’30s and half of the ’40s were a write-off because of the yahoo in the white house. Can we expect 2010
    through 2025 to be another utopian, progressive write-off?

  • alice

    Is it starting to become clear yet. We have the most dangerous assult, on our very way of life. Everything that made this country so great, is being dismantled brick by brick rite before our eyes. It’s been happening for a while now. Some 70% of all college professors are either socialist, or worse marxist. But in the Ivy League colleges the Libs, socialist, marxist professors are near 90%. Yea that’s where the so-called great 1 Obama/Rev Right/Castro/Stalin/Chaves, maybe even Satan,was invented. Most assured anti-American, divide and destroy, everything that made this country great, ruin our currency, take our freedom, that hasen’t happened yet “thank God “. These anti-American jerks, lot’s of blame to go around, Pelosi, Reid, and OBAMA’s choice, the czars, no body but we wanted, should be shot for treason, are in complete control, to tear apart, ruin, destroy, dismantle, doesn’t matter what it’s called. Their ideal upotain goal is nothing less than the complete collapse of this Country. The end justified by any means, is thier ultimate desire.”Saul Alunski”…

    • Kellie

      Excuse me?!?! Are you trying to blame the Great Depression on FDR?! Great God Almighty, woman, turn down the radio with Rush blaring in your ear long enough to read a damn history book!!! AND I QUOTE,

      “Hoover served as secretary of commerce for seven years, under presidents Harding and Coolidge, and became the Republican presidential nominee in the Election of 1928. He was elected by an overwhelming majority. During his first few months as president, Hoover pushed Congress to set aside money for national park land, to reform prisons, and provide better education on American Indian reservations. He also urged Congress to pass the Agricultural Marketing Act, which helped farmers set up cooperatives, control surpluses, and keep the food supply steady.

      After just eight months in office, on October 29, 1929, the stock market crashed, fueling a growing depression that became the most severe economic crisis the United States had ever known, and second only to the Civil War as the greatest domestic crisis in the nation’s history.

      Although Hoover has been blamed for the stock market crash, he, in fact, warned President Coolidge in 1925 about the dangers of excessive stock market speculation. He again expressed concern while running for president in 1928.” Taken from http://www.u-s-history.com/pages/h1580.html

      So, get your politicians and parties straight, lady, and quit blindly believing all that crap Fox News is broadcasting!!! We’re in real trouble in this country and all you are doing is pointing fingers across the aisle…use your brain and a book or two!

  • James

    The relative amount of gold to other commodities (e.g., beans, wheat rice) stays pretty constant. When the price of gold goes up in its dollar price, it means the value of the dollar has gone down. Back in 1933, gold was $25/oz., today it’s over $1000/oz., which means our dollar has lost 97.5% of its value since then. This inflation is caused by the government’s deficit spending. Borrowing and spending trillions of dollars into the economy (money that hasn’t yet been earned) dilutes the dollar’s value and raises prices. Back in the 1930s a nickel would buy a double-dip ice cream cone (real ice cream, back then that’s the only kind that existed). Gold and ice cream haven’t become more valuable, our dollar has lost its value. In my opinion, the dollar is being borrowed and spent out of existence to make way for a universal currency.

  • anne

    How to bring a country to its knees? Devalue the currency with an untimate goal of changing the currency.

    • s c

      Quite true, Anne. But, don’t forget that to insure this approach, our wannabe slavemasters needed to implode the so-called ‘educational system’ (they did a good job of it, too). That way, they could rely on easy votes from sheepoid voters, world-class morons in Congress who can’t and won’t read legislation they want passed, and with the help of a prostituted ‘mainstream’ media, they would know in advance that free speech would be thwarted (in the name of being truly ‘progressive,’ of course). Stalin and Mao would be proud and green with envy (most likely, Hitler, too).

      • DaveH

        Lately, I’ve seen a lot of videos with Obama visiting various classrooms. And unfortunately my own representative (Democrat) sent out flyers depicting her talking to the school children. Of course, they are always doing it to benefit the kids. Sure. That’s what the teachers are for.
        Next, Obama will be asking the kids to turn in their parents for anti-government activities as they did in the USSR.

        • Kellie

          And what was George W. Bush doing when the terrorists hit the World Trade Center? Yes, children…..READING TO CHILDREN at school! Did you keep your child home THAT day in protest?!?!?!?!

  • Mark

    I hate seeing what is happening to our country. It is without a doubt time for true “Americans” to stand up against those in political office and say enough is enough! We the people are no longer represented by our government, they only support special interest groups who are donating money to their campaigns and wallets. How much longer are we going to put up with these “Yahoo’s” before we get them out of office. The problem lies with Democrats and Republicans, where are the Patriots?

  • Lola C

    In the end silver will be worthless/tossed in the streets/and the government will take your gold from you…

    Better get your seed(if they let you, that is), guns and bullets ready…

  • http:nationalstudentloans.info Kris Vasmadjides

    It looks like les Canadiens’ Cinderella story is over.

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