-- Posted Sunday, 4 February 2007 | Digg This Article
Article originally submitted to subscribers on 1st February 2007…
Rumors abound!
There’s nothing quite like the unexpected to get Wall Street Hot and Bothered.
And here I’m talking about the recent move in Gold and the Dollar.
Historically, Gold and the Dollar are like Oil and Water. They just don’t mix!
The US Dollar is the Chief Fiat Currency.
Its Generals would like nothing more than to see Gold, the un-inflatable store of wealth Disappear.
Gold is the anti-Dollar.
It would therefore be reasonable to see Gold and the Dollar trade exactly opposite. That’s what we see most of the time.
But wait!
What’s this?
Since the beginning of 2007 these Archenemies have been moving higher together. What gives??
Chart 1- US Dollar (top) and Gold (bottom) both moving higher (green rectangle)
Has the link between Gold and the Dollar severed?
Is it no longer safe to assume there is a negative correlation between the two?
The answer ofcourse is No.
What’s happening is that the Dollar and Gold are both discounting a disinflationary scenario.
What’s the Dollar looking at?
The Dollar is discounting the immediate effect of higher US interest rates.
Since the beginning of the year, US rates have risen along the entire Yield curve. Higher yields make US Debt more attractive which in turn increases the demand for Dollars. A rising Dollar makes imports cheaper. That’s deflationary and symptomatic of an economic slowdown.
And what’s Gold seeing?
Gold continues to act as a counter-cyclical barometer. Since the beginning of the year it has consistently outperformed economically sensitive commodities such as Oil and industrial metals. Supporting the case for an economic slowdown.
But more importantly, Gold is responding to a widening of the yield curve. During the latest Bond Market malady, Long term rates have risen quicker than short term rates.
Chart 2 – Long term yields rising faster than short term yields causing the yield curve to widen
The rationale is that the yield curve will widen in an attempt to alleviate tight monetary conditions. In other words, the spread between long-term and short-term rates increase in order to entice investors to borrow short and invest long (increasing liquidity) as a natural reaction to a slowing economy
So who’s right?
If Gold and the Dollar cannot move together forever. If they are destined to decouple back to their natural order, which will be going Up and which will be going Down?
The answer:
Both are right!
Under a disinflationary scenario, both Gold and the Dollar would move higher as market participants move towards safer assets.
However, when investors realize that cash is not as safe as is commonly held. That Cash is subject to debasement through money printing and that the Fed is about to go into hyper drive. When that realization hits, the Dollar will reverse lower and Gold continue higher as it’s quality as the ultimate store of value is realized.
The last time Gold and the Dollar moved together (higher) in a meaningful way was the first half of 2001 which was the beginning of the 2000 – 2002 Bear Market in Stocks.
A coincidence?
I think not!
More commentary and stock picks follow for subscribers…
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Greg Silberman CA(SA), CFA
greg@goldandoilstocks.com
I am an investor and newsletter writer specializing in Junior Mining and Energy Stocks.
Please visit my website for a free trial to my newsletter.
Click here: http://blog.goldandoilstocks.com
This article is intended solely for information purposes. The opinions are those of the author only. Please conduct further research and consult your financial advisor before making any investment/trading decision. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.
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-- Posted Sunday, 4 February 2007 | Digg This Article
