Gold's Move Back To $1000
Emanuel Balarie, August 29th, 2008
Over the past several months, gold has sold off in a rather quick and dramatic fashion. At the center of this sell-off, has been a sharp rally in the US dollar. While there are several fundamental factors that ultimately dictate the direction of gold, I continue to believe that its relationship with the US dollar is perhaps the most important. More often than not, if we see a strong rally in the US dollar- we will see a sell-off in gold. If we see a sell-off in the US dollar, we will often see move up in gold.
Consider the following chart that depicts the movement of the US dollar vs. Gold.
Of course, it is also important to note that there are times where this inverse relationship does not play out. You can see this by looking at the above chart. In January, for instance, both gold and the US dollar moved higher. By in large, however, this I inverse relationship ultimately plays out.
US Dollar Weakness to Continue
Since mid July, when gold sold off rapidly, the US dollar appreciated by about 8% against the euro and 5% against the yen. The question, of course, is whether or not this trend will continue? The big negatives against the US dollar have been a widening twin deficits and a weakening US economy. This of course, makes perfect sense. When you buy a currency of a country, you are really buying into the strength of its economy. If the country consumes (imports) more than produces (exports), it is simply going into debt. This is really quite similar to the US consumer and his effect on the US economy.
One of the reasons for the recent rally in the US dollar has been the recent positive fundamental data surrounding the US trade deficit. In June, the US trade deficit shrank sharply- exports were up 4.0 %( $164.4 billion) and imports only increased by 1.8 %( $221.2 billion). I don't expect, however, this trend to last. While the deficit narrowed, the US is still highly dependent on other countries for imports. Logically, this makes sense. The US is no longer a manufacturing "powerhouse" and we are reliant on other countries for imports of oil and other resources. In fact, while the trade deficit narrowed in June, the oil deficit grew to a record high of 36.4 billion dollars. Consider the following chart provided by the United States International Trade Commission. It shows the relationship of the US and its trading partners.
U.S. Trade Balance, by Partner Country 2007in descending order of trade turnover (imports plus exports)
| Partner country | Imports for Consumption | Domestic Exports | Merchandise Trade Balance |
----million dollars---- | ||||
1 | 1220.--Canada | $312,504.5 | $213,118.7 | ($99,385.8) |
2 | 5700.--China | $323,085.5 | $61,013.2 | ($262,072.3) |
3 | 2010.--Mexico | $210,158.8 | $119,381.1 | ($90,777.7) |
4 | 5880.--Japan | $144,927.9 | $58,095.8 | ($86,832.2) |
5 | 4280.--Germany | $94,416.2 | $44,294.1 | ($50,122.1) |
6 | 4120.--United Kingdom | $56,872.8 | $45,435.6 | ($11,437.2) |
7 | 5800.--Korea | $45,368.3 | $33,011.6 | ($12,356.7) |
8 | 4279.--France | $41,236.6 | $25,784.4 | ($15,452.2) |
9 | 5830.--Taiwan | $38,052.4 | $24,541.0 | ($13,511.4) |
10 | 4210.--Netherlands | $19,259.6 | $30,535.8 | $11,276.2 |
You can clearly see that we are indebted 9 out of the 10 countries we trade with. And In fact, the US has a trade deficit with a majority of countries (http://dataweb.usitc.gov/scripts/cy_m3_run.asp).
In terms of other economic data, it is evidently clear that the housing and credit crisis is far from over. While some pundits might spin the recent GDP numbers into a positive, the US is still in the midst of a recession. All of these negative factors ultimately translate into foreign and private investors not wanting to purchase US dollars. If anything, foreign central banks are still looking to diversify (sell) away from their heavy US dollar exposure. All these factors will ultimately lead to lower US dollar lows.
Given the fact that the underlying fundamentals surrounding the US have not improved, gold investors should feel confident that the recent sell-off in the gold market did not signal an end to this bull market. If anything, it presented investors with a buying opportunity.
Back to $1000/ounce
There are several reasons for why I believe that we will likely see a move back to $1000/ounce over the next several months. Several gold bulls have clearly articulated this point. And really, it just boils back to the same simple fundamentals that have pushed gold prices higher from the start of this bull market. Rising global inflation, geopolitical tensions, investor demand from emerging economies, central bank buying, and dollar weakness are still adequate reasons for why gold prices are heading higher.
But beyond these longer-term fundamentals, it is always better to buy into a fundamentally strong investment after a sell-off. While the price of gold might bounce back and forth for a couple more weeks, I feel that the sell-off in the gold market is just about done. While I don't subscribe to buying investments on the way down, it now seems that the price of gold has renewed its upward trend.
What is also positive for gold is that we are now heading into a seasonally strong period for gold. Jewelry demand for gold increases significantly during the fall season and many manufacturers start purchasing gold in the fall months. You will notice in the following chart, that the price of gold has climbed every year- since 2005- from September to December.
Consider the following (approximate) statistic showing gold's moves from the end of august to its highest point during the Sept-December months. It is interesting to note that the same trends appear prior to the start of this bull market in 2001.
Year | End of August Price | Sept-Dec High | % Gain |
1998 | 280 | 308 | 9% |
1999 | 258 | 338 | 24% |
2000 | 284 | 285 | 1% |
2001 | 277 | 297 | 7% |
2002 | 314 | 356 | 12% |
2003 | 377 | 418 | 10% |
2004 | 414 | 459 | 10% |
2005 | 441 | 545 | 19% |
2006 | 640 | 655 | 2% |
2007 | 700 | 850 | 18% |
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