In the early stages of this new gold bull market that got underway in the latter part of 2001, shares of gold mining companies led the way.  While the yellow metal itself plodded higher but in a relatively unspectacular way, gold shares soared; our recommended basket more than doubled between the Fall of 2001 and the sector’s peak in June, 2002.

            Since that time, however, gold shares have under performed the metal itself.   Even a brief, albeit unsustainable, spike in spot gold to $390 per ounce in early February failed to bring mining shares along with it commensurately; even at that point (with gold $60 higher) the gold mining sector couldn’t move above last June’s levels.

            Gold shares did seem ready to regain their usual role of anticipating a new upward move in gold when, back in mid-March, they bottomed and then turned higher, even as gold itself continued to decline to its recent lows a shade under $320 per ounce.   Curiously, however, the gold stock sector again began to slip; first failing to move convincingly above key resistance levels and then—until the last couple days—failing as well to keep up with a gold price which suddenly has some substantial tail wind.

            While there are several possible reasons for this, real or imagined, there are two chief ones in my view.  First, significant short positions had been taken in gold shares many weeks back, as hedge funds (primarily) were betting that the sector would cool off.  They were correct.  This activity has helped keep gold shares in check. However, with gold’s biggest dangers of declining seeming to have abated, we may see more earnest short covering, which will help the mining shares catch up with gold’s own price strength.

            Second, it must be remembered that sometimes the macroeconomic picture might not be good for gold mining companies, even if the price of gold is doing well.  This can particularly occur if there are fears about overall the overall economy’s health.  Keep in mind that jewelry demand comprises the majority of overall demand for the yellow metal; and all other things being equal, a contraction in the world economy and, consequently, in said demand sure can’t be good.

            However, there are many more reasons why gold—though it could still have some near-term trouble getting back above the psychologically important $340 per ounce hump—may finally be poised to more significantly reassert its long term bullish trend.  Most of the factors that gave rise to the birth of this bull market in late 2001 remain fairly well in tact, though a couple of elements (such as jewelry demand) are a bit worrisome.  Helping out more than ever currently, though, is the action concerning the U.S. dollar.

            You already know that the dollar has lost ground against the euro over the last year.  At its zenith, it only took a bit over 80 cents to buy a euro.  Today, it takes nearly $1.12, bringing it back most of the way to the $1.17 per euro level that existed when the new currency was introduced four years ago.

            There are many reasons for this, which I have previously expounded on.   Not all of them, frankly, are debilitating for either the U.S. economy or U.S. markets all by themselves.  However, two factors suggest that—though sharp rebounds may from time to time occur—the worst may still be ahead for the U.S. currency:

            First, the dollar has not enjoyed anything like the kind of “post-war bounce” that we’ve seen to some extent on Wall Street.  Quite the contrary; the broad U.S. dollar index is threatening to break below its previous lows, a development which would no doubt invite more “piling on” by hedge funds and assorted other investors.  This bearish attitude is based on many factors:  record Treasury borrowing, burgeoning external debts to the rest of the world, an economic outlook that is not exactly rosy, the heightened enmity between the U.S. and much of the rest of the world over our foreign policy and, last but not least, what could be the beginning of a more concerted international “boycott” of the dollar.  Whatever the many reasons you might like to choose from, it’s telling that we have a weak dollar after Saddam Hussein has been vanquished, and even as other major economies are in arguably worse shape than our own.

            Second—and a development that is truly extraordinary—currency traders have in recent days been giving their strongest signals yet that they now believe there shall be no return to previous glory days for the greenback.  Ever since the great bull market for the dollar began in 1995, it was routine for currency traders to borrow currencies both weak and cheap (such as the Japanese yen) and invest them elsewhere in anticipation of both relative currency strength and higher interest rates, allowing this “carry trade” to generate profits.  The dollar was clearly the depository and beneficiary of this, helping to explain how the dollar itself became a momentum-created bubble over several years’ time.

            Now, of all things, we’re seeing reports of traders borrowing dollars and investing them in safer and higher-yielding currencies.  Not only the euro is benefiting from this; higher-yielding (and more commodity-dependent) currencies such as the Canadian and Australian dollars are getting some action as well.  The significance of this sea change in the attitude of the currency markets cannot be overstated and, though this very different treatment of the U.S. dollar will be inviting even more volatility in its value down the road, it nevertheless shows the growing conviction that the buck’s long term trend has been decided upon by those who matter most.

            A weaker U.S. dollar—which in the end will do more harm than good, no matter how much you hear about how wonderful it will be for some multinationals who might temporarily be able to export more—will ultimately be inflationary.  It could cause financial turmoil world-wide.  That will be a bonus for gold, on top of the many reasons already existing, and into which I go into great detail in my latest research report on the sector.

            Accordingly, just this morning I increased both my recommended gold sector allocation for subscribers to The National Investor, as well as “re-recommending” yet another two previous winners (one of which proved a shocker to some!)   Eventually, gold’s renewed strength will reinvigorate gold shares more, especially if some of those still short gold stocks get scared. 

In light of the dollar’s lethargy and with spot gold showing some life, I no longer want to advise hanging around to try to micro-manage our process of picking the absolute bottom in gold shares’ correction.  In fact, if gold can manage to vault $340 with some decent momentum, I’ll likely become more bullish—and add more recommendations in the sector—still. 

-- Posted Thursday, 1 May 2003 | Digg This Article