The Gospel of Higher Gold

By: Alex Wallenwein | Thu, Mar 4, 2004
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Gold investors still get depressed on days like today, Tuesday March 2, 2004, when the dollar suddenly jumps and gold goes skiing. But they shouldn't.

Gold is not just in a primary bull market. Bull markets are always followed by bear markets, and vice versa. Instead, gold is in a permanent adjustment period - and it is adjusting upwards.

Naturally, when I say "gold" is in an adjustment period, it is not really gold but fiat that is being adjusted, namely: downward.

After the horrendous carnage of the nineties, when gold investors' hoped-for profits were systematically blocked and eaten up, we are all still shell-shocked. Everyone is still in flight- mode at the earliest sign of any short-term price reversals. That's just human psychology - but it's very, very costly.

Investor psychology never changes. Even though gold investors have the advantage of being able to see behind the shenanigans of the paper-world, human emotions are what they are, and they usually lead our decisions. Rationalizations mostly come after the fact.

But this is a crucial time in human history, especially in the history of the gold market. Well, this needs correction again: there's nothing new in the history of the gold market. The huge changes we are witnessing are happening in the fiat system. Gold is just there, providing refuge, a safe-harbor for all those who know enough to seek it. Paper is what's fluttering all around us in the winds of the market.

However, it's easier to make a point by speaking the same language everyone else is speaking, so we'll continue as if things were happening to gold instead of to paper.

What's happening to gold, then?

For once, it looks like we are witnessing the first trading days where the almost perfect correlation between gold and the dollar appears to be breaking up. Just look at these two Kitco mini-charts from today:

One thing is immediately apparent: Gold started its downhill run way before the dollar even began to think about kicking up its heels. Gold, after being very stable during London trading hours at $400.00 immediately turned down upon the New York open and bottomed out at 12 pm EST.

The dollar, however, did not pick up until two full hours later, near 10 am, and it gained two full cents on the day, also ending its run at 12 pm.

Yesterday, March 1, 2004, gold saw an immediate rise from the open til nine o'clock, where it soon faltered and dropped all the way back down to its starting price near $398, had some more ups and downs and closed slightly up about one dollar. The dollar, on the other hand, while dipping during the time gold went up, then rebounded and closed slightly higher than it started, closing near the day's high.

So, yesterday was an example of both the dollar and gold rising in tandem, in absolute terms. A very odd occurrence, given these two benchmarks' almost perfectly inverse relationship during the last six months or so.

The same thing was once true (especially during the late nineties) about gold and the Dow, or stocks in general. We all know that this former correlation in now a total relic. Gold and stocks have been moving up side by side since about August/September of last year, and have moved sideways together since early February. (See: Gold is Breaking Free.

Two days do not a trend make - yet, but what these two days are indicating is likely to turn into a trend, just like the last time in September 2003. Not that the dollar and gold will be moving up together for any length of time, but that the vise grip the dollar recently seemed to have on gold is getting looser and looser.

So, how does that indicate "higher gold?" It doesn't. It's just a noteworthy observation.

What does point to perpetually higher gold in the medium to long term is the fact that both the dollar and the US economy as the world's "engine of economic growth" are essentially finished. There is literally no way out. This doesn't mean there will be a sudden, catastrophic crash, although there could be. It means both are on a long, long downward path that has no escape.

Long Term Rates: The Economy's Damocles' Sword

The crazy thing is that there is a similar lack of correlation between the dollar and the US economy. In the nineties, a strong dollar was a prerequisite for keeping the stock racket going. Foreign investor's assets had to be lured to the US to perpetuate the over-exuberant stock bull. A weaker dollar would have made foreigners looking for returns on their money look elsewhere.

Now, foreigners are buying US assets - mainly treasuries - because the dollar is sinking. Go figure.

This is because the nineties have brought us the Asian "tigers" whose fortunes now depend on attracting US consumers to buy their goods. As the dollar falls, they must keep their own currencies lower so as not to lose profitability by making their goods too expensive for Americans to buy. So they print their own currencies and buy dollars to pay for US treasuries. That's why treasury yields have stabilized.

One can say that, in the past, Asian exporters were buying dollars because they wanted to: They were being lured into it by an artificially strong dollar. Now, they are forced to buy dollars: to keep their own currencies low in order to maintain export price competitiveness. A very dangerous game, indeed.

For the time being, Greenspan and Bush (GreenBush) are smiling an uneasy smile upon the dollar's misfortunes. The name of the game is to give US exporters some welcome relief from high dollar values which destroy export viability - all in a desperate attempt at rekindling US job creation.

But it doesn't matter which way they turn. The specter of rising long term interest rates is blocking every single way that could lead the dollar and the economy out of this dilemma - except for the way down.

The reason is the cash-strapped, totally over-extended US consumer. Consumers are up to their necks in mortgage re-fi and other debt. Much of that is extremely interest rate sensitive because many of them were suckered into buying ARMs. As long term rates rise, their debt-servicing bills get bigger. Way bigger. And job creation is still just limping along, so where is the cash gonna come from?

If consumers are forced to stop spending because they have too much interest to pay, the economy will go the way of all things finite. Either they stop spending to keep their homes, or they default and credit starts drying up and the housing market will collapse. If they default, they still have to pay rent somewhere, so much of the "freed up" cash is still not going to go into consumption of goods and services. Result: The economy tanks.

So, why would rates have to rise?

Let's assume the dollar were to rise from here on. What would happen?

Maybe this Friday's jobs report will be a glowing one. If so, stocks will certainly get a huge boost, and so will the dollar. A rising dollar takes an enormous load off the exporters' shoulders. They no longer need to buy treasuries to keep their currencies down. That reduces demand for treasuries, puts downward pressure on their prices and upward pressure on their yields - which happen to determine long term interest rates.

China is the biggest and baddest of all the Asian exporters. In a very real way, the ChiComs are carrying in their collective hands the key to the utter destruction of the already teetering, artificially brought back to life and unnaturally juiced-up US "Frankenstein" economy. And they can do it by blowing us kisses and wishing us well, claiming to do just what we asked them to do.

How is that?

All they have to do is accede to US demands to let their currency float, or at least loosen the US treasury bands by which they have tied it to the dollar. If China gives the yuan a wider band in which to move, say 2 to 5 percent from its current target, and then gradually gives it more reign as time goes on, they will likewise have to buy less treasuries to keep their currency pegged to a falling dollar. Not only that, in doing so they are even complying with WTO mandates ahead of their five-year deadline from the date of joining.

On top of that, a rising dollar, aside from choking off export demand for US goods, will free the Asians up to do what? Buy euros - which will push the dollar down again - anyway.

On the other hand, let's assume that neither the dollar will rise significantly nor that the Asians start buying less treasury debt. Let's assume all of that stays fixed and the US economy starts adding jobs and steam, people here are better able to pay their bills without going further into debt, and the stock market has another giant leg up. What would happen?

Stocks and bonds have an inverse relationship. When stocks boom, money flows out of the bond market and into stocks, driving up yields and therefore - interest rates. Can't win for losing anymore.

Now comes the US budget deficit. The deficit is funded by the US selling treasuries. We are seeing record deficits, so we need to sell record treasuries. But if the Asians don't want to buy anymore, we have a glut that will drive yields up again.

Is there any way out?

Maybe if the Fed keeps printing money to buy up all of that treasury debt slack, like Greenspan has already threatenend. Can we make it that way?

No. Sorry. That will give us a dollar glut to add to the already existing dollar glut from international central banks unloading their dollar reserves in favor of euros. It will drive prices up - and the dollar down.

Add to all of that the fact that OPEC may, at some point, consider it necessary to "go euro," and you have a recipe for a guaranteed dollar disaster. The only question is: how long will it take? That it will indeed happen is a forgone conclusion. It will likely not be a sudden shift. There will be currency "baskets" first to lessen the blow to the dollar, but eventually the dollar will be sitting in its very own basket - a handbasket with a predestined route.

And then there are a number of other points that have already been discussed at length, and so will only be listed in key point format:

And then there is one last important point. In 1980, when gold went to $850, Paul Volcker was able to raise interest rates sky-high to attract funds back to the dollar. This time around that is not possible for reasons already discussed.

All of that means gold will go "higher."

This is a long, drawn out process, if we are lucky. Americans would do well to start recognizing that fact - and prepare!

Got gold?


Author: Alex Wallenwein

Alex Wallenwein
Editor, Publisher
The Euro vs Dollar Monitor

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