June 21, 2005
WHAT'S UP WITH GOLD?
Gold is money, say the metal's fans. But that doesn't necessarily mean it has a life of its own. Or does it?
The conventional wisdom holds that gold's price moves only in reaction to the world's reserve currency. That is, when the dollar rises, gold falls; when the buck slides, gold jumps. Negative correlation, as the quants like to say.
The relationship is as one would expect in a universe dominated by the global economy's most important fiat money. To the extent that the standard bearer of faith in government paper stumbles, it's only reasonable to see the historical alternative to states' monetary systems take wing, or vice versa.
But can gold rally of its own accord? Or fall in a vacuum? Perhaps, or perhaps not. Whatever the answer, the precious metal’s rally of late smacks of something a bit out of the ordinary when you consider that the dollar’s been strong too. Is the traditional relationship on the skids? Indeed, the precious metal trades at roughly $438 an ounce as we write today. That’s a $20 climb in about two weeks
"The recent historical connection between the dollar and gold has broken down," Jeremy East, global head of precious metals at Commerzbank, told Reuters last week.
Ah, but why? And what does it mean? That may take some time to decipher, but more than a few explanations are already floating about. One theory is that gold’s historical role as a store of international value is enjoying a renaissance now that the euro’s reputation has been damaged after France and Holland snubbed the European constitution. Never mind that the liquidity of gold trading is but a fraction, and a tiny one at that, relative to the euro. “The argument for fund interest in gold as an alternative to the euro is fatally flawed because the gold market is simply too small,” Barclays Capital analyst Kamal Naqvi tells Bloomberg News. Gold’s $10 billion of daily trading is a drop in the bucket next to the $700 billion in the euro.
Still, there are those who say that gold is in play again as a safe haven for the disillusioned fleeing the euro. And to the extent traders are selling euros in search of gold, the relatively thin liquidity in gold next to the euro helps drive up the price of the precious metal.
As usual, Euro Pacific Capital’s Peter Schiff has his own view of what Mr. Market’s saying about gold. "The fact that gold's strength comes not as a result of weakness in the dollar, but of weakness in the euro, suggests that in the minds of many, the euro has already replaced the dollar as the reserve currency of choice,” he writes on his firm’s web site. “However, now that fears have emerged with regard to the euro, safe haven money is going into gold. That is why over the past several weeks, the price of gold has risen sharply in terms of all currencies. In other words, this is a legitimate gold rally, not simply a dollar decline.”
Perhaps, although gold bugs aren’t necessarily of one mind on the current rally in their favorite metal. Gold isn’t strong,” writes Julian D. W. Phillips of AuthenticMoney.com via Goldseek.com. Rather, the dollar is weak, but the euro is weaker, which only lends the illusion that that the dollar’s stronger, he opines.
Could it really be that simple?
Maybe, but it's going to take more than a little convincing, whether from the dollar's or the euro's perspective. According to Bloomberg, for instance, gold's correlation to the euro "began to diverge" after Europe sent the European Union constitution packing. "I'm not ready to throw away a five-year correlation with the currencies," Leonard Kaplan, president of Prospector Asset Management. "I don't believe that gold can rally on its own."
Posted by jp at June 21, 2005 4:35 PM
As the imbalances grow, so will the appetite for gold, the universal currency for the last 6000 years. In my early days, that is 10-20 years ago I always got this advice from portfolio managers for private clients that one should hold 5-10 percent of her/his assets in bullion. I doubt that the actual proportion is higher than 1 percent. Once this rule will be followed again it is going to go through the roof.
Gold is the high priests of fiat money (i.e. central bankers) worst enemy. It would be also worthwhile starting a discussion why central banks show only a combined position of "gold and gold receivables" on their balance sheets as latter is just a paper claim on the real stuff that gets sold short. How was that about counter-party risk even the Fed (Kohn) is speaking of these days?
Posted by: The Prudent Investor at June 22, 2005 5:53 AM
photos and movies from India and China discover the hidden truth - people there like gold.
Posted by: arkady at June 21, 2005 6:37 PM