Gold's Rise Goes Beyond the Dollar's Demise

Save the Day

Currencies are first and foremost relative prices--in essence, they are measures of the intrinsic value of one economy versus another. On that basis, the world has had no compunction in writing down the value of the United States over the past several years. The dollar, relative to the currencies of most of America's trading partners, is off about 20 percent from its early 2002 peak. Recently it has hit new lows against the Euro and a high-flying Canadian currency, likely a harbinger of more weakness to come.

Why worry about a weaker dollar? The United States imported $2.2 trillion of goods and services in 2006. A sharp drop in the dollar makes those items considerably more expensive--the functional equivalent of a tax hike on consumers. It could also stoke fears of inflation--driving up long-term interest rates and putting more pressure on financial markets and the economy, exacerbating recession risks. Optimists may draw comfort from the vision of an export-led renewal arising from a more competitive dollar. Yet history is clear: no nation has ever devalued its way into prosperity (Emphasis added).

So far, the dollar's weakness has not been a big deal. That may now be about to change. Relative to the rest of the world, the United States looks painfully subprime. So does its currency.

The New York Time, 09/25/07
Stephen S. Roach, Chairman of Morgan Stanley Asia

It's Official: U.S. is World's Discount Mall

The dollar is now the economic equivalent of the Blue Light Special, and we all know what happened to K-mart. I sit here not as an economist or a student of the economy, but as an American reporter of business matters and the stock market who tries to simplify things--and from my vantage point the falling dollar has done little more than make the U.S. the discount mall to the world.

I'm at a loss to understand why that should be a good thing, especially as other countries decide they'd rather invest in Tiffany than Target.

MarketBlog, 11/07/07
Herb Greenberg

Market Forces: Commodity Prices Surge

Furthermore, gold--which shares crude oil's status as an alternative investment and hedge against inflation at a time of U.S. dollar weakness--has also spiked in recent months. The price of gold hit $802.50 per ounce earlier in the week--its highest level since January 1980. Compared to crude oil, the gains appear remarkably similar; both have roughly doubled in price over the past 24 months, with noticeable spikes in recent months.

Figure 1

Source: Moody's Economy.com, DismalScientist

Perhaps more importantly, however, the continual weakening of the U.S. dollar is amplifying the U.S. dollar-denominated price of crude oil. To preserve real export revenues, oil-producing countries are demanding higher U.S. dollar prices for crude oil to compensate for the falling greenback.

Figure 2

Source: Moody's Economy.com, DismalScientist

This latter influence, along with speculative funds being attracted following recent gains, is perhaps the predominant reason why oil prices have remained elevated beyond the traditional end of the Northern Hemisphere driving season; the time when easing demand pressures usually see the price retreat. Nevertheless, the elevated price level persisting into October and November is not entirely unusual, as can be seen in the chart, which shows the elevated levels in 2004 and 2005 persisted for some time after the end of the Northern Hemisphere summer prior to retreating. (An interesting aside, the chart also shows the percentage increase in the price of crude oil over the course of this year is not unprecedented considering the increases, which occurred in 2004 and 2005.) Given continuing U.S. dollar weakness, it is likely market forces will see the price remain higher for longer this year.

Commodities present an alternative investment and hedge against inflation relative to the usual safe-haven assets of fixed-income securities at times of U.S. dollar weakness. With current economic conditions--particularly the weak U.S. dollar--likely to prevail for some time, commodities will continue to attract an increasing amount of speculative investment. This will prolong demand-side support for commodity prices in the months ahead.

DismalScientist, 11/01/07
Matt Robinson

The above excerpts paint a clear picture of what is going on with the dollar's slide and the jump in commodities, with oil and gold taking center stage. Gold is at multi decade highs and is perhaps only days away from an all-time nominal high.

The financial media are trying to paint the picture that the rise in gold is purely from the slide in the dollar, and nothing could be further from the truth, as the dollar has slid 6% over the past three months while gold has risen 22.5%. Thus, gold's advancement is nearly four times the dollar's percentage decline, indicating the dollar's fall only explains part of the rise in gold.

Figure 3. 3-Month Performance (%)

Source: StockCharts.com

Foreign countries have been diversifying their reserves away from dollar-denominated assets and towards other currencies, which explains the weakness in the dollar. For example, today the U.S. Treasury sold billion of 10-year notes at a yield of 4.353%, the lowest since September 2005. Additionally, the bid/cover ratio, which measures the demand by comparing the number of bids to the amount of securities sold, came in at 2.34, lower than the number anticipated by a survey down by Bloomberg News, indicating weaker demand.

Foreign countries shifting their reserves away from the dollar and into other currencies are nothing more than rearranging chairs on the Titanic. This point is made abundantly clear when looking at the value of paper money (fiat currencies) versus real money (gold), where every paper currency on the planet is losing its purchasing power relative to real money, not just the dollar.

Figure 4. Dollar/Gold Ratio

Source: StockCharts.com

Figure 5. Australian Dollar/Gold

Source: StockCharts.com

Figure 6. British Pound/Gold

Source: StockCharts.com

Figure 7. Canadian Dollar/Gold

Source: StockCharts.com

Figure 8. Euro/Gold

Source: StockCharts.com

Figure 9. Japanese Yen/Gold

Source: StockCharts.com

Figure 10. Swiss Franc/Gold

Source: StockCharts.com

The move in gold in excess of the dollar's decline is most likely due to a loss of confidence in fiat currencies around the globe, where rampant money printing is not just a U.S. phenomenon. Increased demand for gold is likely coming from investors and nations seeking protection from inflation as gold remains the ultimate inflation hedge.

Speaking of inflation, the global money printing presses are leading to rising inflation all over the world. David Galland, editor and writer of The Room, a weekly newsletter from Casey Research, made this clear in last week's piece in the section titled, "Inflation, Inflation Everywhere."

One of our more controversial long-term forecasts is that fiat currencies in all their many colors are headed for the trash bin of history.

That's because they are all backed by the same thing--nothing, really. And while we pick on the U.S. dollar a fair bit -- because it is the nearest to hand -- the U.S. economy that purportedly underpins it is certainly not in the worst shape of its peer group. Take U.S. government debt as a percentage of GNP, for example. In that category, we find the U.S. has a government debt-to-GNP ratio of 62%. But Germany and France ring in at 63%, Canada's ratio is 68% and the current record holder among modernized countries is Japan with a whopping 194%...

On that front, we are continuing to see news out of an increasing number of countries that inflation is starting to become a problem. Some snippets.

Oct 29 (AFP) TEHRAN - President Mahmoud Ahmadinejad was on Monday again criticised over his handling of Iran's economy, with a leading MP protesting against a lack of planning and a cabinet minister expressing concern over inflation. Inflation, which many economists estimate will hit more than 20 percent this year, is an increasing source of anxiety in Iran as sharp rises in basic foodstuffs and services over the past six months hit the poor hardest.

Oct. 31 (Bloomberg) -- European inflation accelerated more than economists forecast in October, while confidence in the economy declined, underlining the European Central Bank's quandary over whether to raise interest rates.

Oct. 31 (Bloomberg) -- Mexico's central bank raised its forecasts for inflation because of a tax increase and 'persistently high' global food prices.

Inflation is indeed quite high in many regions of the globe as a direct result of rampant money printing by virtually every nation on the planet. To illustrate this point using data from Bloomberg, a survey of 38 countries from different regions was done, recording both their inflation rates, as measured by the year-over-year (YOY) percent change in CPI, and their YOY percent change in money supply growth. The results were extraordinary.

The average inflation rate was 5.52% with the average money supply growth rate coming in at 16.5%. Here is a small sample of the data from some of the countries from around the world.

The graphical summary of the 38 countries surveyed is shown below by region, with a positive trend seen between money supply growth rates and inflation rates. Please note that the high inflation rate and monetary growth rate for Europe is skewed by several of the Baltic states, such as Lithuania, Latvia, and Estonia, but the trend is still the same.

Figure 11

Data: Bloomberg

Taking the data from the 38 countries and plotting the inflation rate (CPI) versus the money supply growth rate shows a direct positive relationship, where the growth in the money supply explains roughly 70% of the variation in inflation.

Figure 12

Data: Bloomberg

As the above data illustrates, the surge in the movement of gold above the decline in the dollar is likely explained by a loss of confidence in global currencies, with investors and foreign countries diversifying their assets to include the only true example of real money, gold.

Gold's advance is likely to continue much longer and higher than most anticipate. Financial pundits are calling gold a bubble and saying it's unsustainable. In reality, what is unsustainable (and which makes gold's move sustainable), is the rampant global money printing. The inflation rates shown above are not a result of the current money printing occurring globally, but are actually the result of earlier money printing as it takes time for new money to trickle down through the economy.

Thus, the CURRENT money supply growth rates will influence inflation in the future, which should lead to rising interest rates to compensate fixed-income investors, as well as rising gold and commodity prices.

Translation: gold is more likely to break 1000 before Google.

Today's Market

'Wall Street Tumbles As Dollar Slides'

This was the top news story from Yahoo Finance today as the markets sold off on a slew of negative news. The dollar continued its slide to new lows, which likely contributed to the weakest US Treasury offer for 10-year U.S. Treasury notes in over two years.

Other negative economic news today that did not receive as much press was a sharp drop off in consumer demand for credit. Consumer demand for credit rose $3.7 billion dollars in September at an annualized 1.8% growth rate, significantly lower than August's reading of $15.4 billion and an annualized growth rate of 7.5%. The weakness in credit demand was principally the result from a meager increase in non-revolving consumer credit, which includes big ticket items like vehicles. The weaker demand for non-revolving credit indicates how consumers are responding to the credit crisis by lowering their willingness to take on more debt for big ticket items.

The markets did not respond well to a weaker dollar and negative economic news. The Dow Jones Industrial Average fell 360.92 points to close at 13300.02 (-2.64%), the S&P 500 fell 44.65 points to close at 1475.62 (-2.94%), and the NASDAQ lost 76.42 points to close at 2748.76 (-2.70%).

There was a strong flight to quality as short term Treasury yields fell, with the yield on the 3-month T-Bill falling 27 basis points (-7.44%) to close at a yield of 3.36%. The dollar index was down on the day, falling 0.47 points to close at a new low of 75.56. Declining issues represented 88% and 78% for the NYSE and NASDAQ respectively, reflecting a fairly broad based decline.

The best performing sectors on the day were the defensively seen consumer staples (-1.37%) and health care (-2.10%) sectors. The sectors putting in the worst performances were financials (-5.06%) and materials (-3.21%).