Gold is poised to break the $500-an-ounce barrier for the first time in 18 years. But you don’t need a new price milestone to realize that the surging price of the precious metal has raised questions anew about the integrity of paper currencies, the dollar in particular.
On first glance, one could reason that the surge in gold prices virtually assures that the Fed will keep raising interest rates. The bull market in gold is partly a reflection of growing anxiety over the dollar’s value, an asset that’s managed by the Fed.
But the anxiety recently has been limited to pushing up gold’s price. The dollar, by contrast, has suffered no fallout from the enhanced popularity of the precious metal. Indeed, the U.S. Dollar Index has been in a mini bull market of its own in recent months.
The dollar’s rally can be attributed to America’s ongoing economic expansion and, more importantly, the interest-rate premium that continues to inhabit U.S. bonds. The 10-year Treasury currently yields 4.44% vs. 3.45% for the equivalent in Germany or 1.46% in Japan, according to Bloomberg. As long as the Fed keeps signaling that it’ll continue raising interest rates, the dollar bulls will likely ignore gold and instead focus on current yield. Until and if they find reason to do otherwise, that is.
BCA Research offered the dollar bulls an excuse for cashing in last week with a commentary that threw cold water on the outlook for continued interest-rate hikes, opining…
First, there are signs that the Fed is nearing the end of its rate tightening cycle. Second, U.S. economic growth is set to slow. Third, speculators are already heavily net long the dollar, which is in stark contrast to one year ago when speculators held huge net short positions. Given these factors, FX traders are increasingly likely to shift their focus back to the massive current account deficit once the Fed finishes tightening. Bottom line: while an overshoot is possible in the near term, there is limited sustainable upside in the trade-weighted U.S. dollar.
When and if the dollar’s rally ends doesn’t change the fact that the gold bulls are celebrating. What’s more, they’re predicting that the rally’s far from over. The reasons vary, but collectively they add up to a powerful psychological force. And that’s nothing to sneeze at since gold is largely driven by psychological forces, having lost its official sanction as “money” in a world of fiat currencies. What are those reasons? Here’s a few:
* The money supply, despite recent Fed rate hikes remains inflationary. “The money supply has been extremely loose – the loosest in 30 years,” Mary Anne Aden, co-editor of The Aden Forecast, said at a gold conference last week in San Francisco, reported ResourceInvestor.com.
* Predictions are rampant that central banks will start buying gold. In fact, the Russian Central Bank earlier this month announced plans to double its gold reserves, according to the Russian News & Information Agency. First Deputy Chairman of the Central Bank Alexei Ulyukayev is quoted as saying that the bank would be purchasing gold “on all markets on which it is available.” Michael Kosares of USA Gold, a precious metals dealer, says the implications are bullish, telling Gold Price News last week that “we should not forget that it was central bank buying that broke the back of the anti-gold cartel in the late 1960s early 1970s. This paved the way for the massive bull market of the 1970s.”
* “Investors are increasingly concerned about the possibility of a housing collapse,” Adrian Day, president of Annapolis, Maryland-based Adrian Day’s Asset Management, tells Bloomberg News today. “Everywhere one looks, there is a reason to own a little insurance,” which for a growing number of people includes gold.