Gold Decouples From USD

Monday, June 13, 2005

Gold has managed to break its high inverse correlation with the US dollar and the US dollar index over the past months. Even Alan Greenspan, who does not like to be reminded of his essay from 1967, when he wrote, "in the absence of the gold standard, there is no way to protect savings from confiscation through inflation," has admitted as recently as this year in a televised Q&A session (forgive me for not being able to source it, but it's engraved on my mind) that he watches the gold price as an indicator for inflation expectations. Taking the words of the wise man as an advice does not bode well for the future, looking at the development of the gold price.

GRAPH: Gold price in US Dollars 2005

While gold was a neutral investment for Euro-thinkers over the last five years, since the rise in gold was offset by the falling dollar, this relation has begun to change recently. The dollar rally that propelled the world's prime reserve currency to a 9-month high today at 1.2033 has been accompanied by an appreciation of gold since the beginning of June.

GRAPH: Euro/USD exchange rate in 2005

A longer term comparison of Gold and the Dow Jones Industrial Average since 1980 shows that gold has formed a major bottom between 1999 and 2001 and has rallied since.
GRAPH: While stocks have shown a negative performance since 2000, gold looks sharp

Next to very strong physical gold demand in the first quarter of 2005, reported here, market participants are attributing the continuing rise in gold also to the fact that the G8 have decided last weekend not to sell off a part of the IMF's gold reserves for the debt relief of 18 highly indebted poor countries which would otherwise have dampened the recent rise significantly.
But there are other opinions too. Goldbugs on various websites have voiced the suspicion that the IMF was in no position to sell a sizable amount of gold as it has leased a good chunk of the yellow metal in its vaults. Had it had to recall these short positions the gold price would have gone through the roof as borrowers would have been forced to cover their short positions.
Gold Is the Second Best Investment Since 1971
Gold is also called the central banker's biggest enemy. Read Alan Greenspan's 38 year old essay linked above. Or read his speech from December 2002 when he said that "it was the case that the price level in 1929 was not much different, on net, from what it had been in 1800. But, in the two decades following the abandonment of the gold standard in 1933, the consumer price index in the United States nearly doubled. And, in the four decades after that, prices quintupled."
President Richard Nixon closed the so called gold window on August 15, 1971. Until then an ounce of gold had cost 35 dollars since Roosevelt had set this price on January 31, 1934. From 1837 to 1933 an ounce of gold was worth 20.67 dollars. This was also the period Greenspan referred to as the period of stable prices.
Gold has been the universal currency for 6000 years. The last 34 years might once be seen as a blip in history.
With a total return of 1,123 percent or 13.5 percent annually since 1971 it is still one of the best investments, outperforming bonds, but not stocks, which performed marginally better with a rise of 1,135 percent, based on a Dow standing at 850 in 1971. But this will be the case again once the Dow falls below 10,300 points. Remembering that there has been no period in history where the stock market managed to rise during a sustained rise of interest rates this point may not be too far away.
Again adhering to Greenspan's rule of thumb that the gold price is a leading indicator for inflation, don't put your bets on a favourable inflation reading on coming Wednesday.


Wikinvest Wire