Gold and Euro: A New Tango For 2010

Sunday, February 21st, 2010

By Dian L. Chu,  Economic Forecasts & Opinions

The U.S. dollar rose, commodity prices dropped and stocks fell last Friday after the Federal Reserve unexpectedly lifted an emergency lending rate for the first time since the financial crisis.

The dollar hit an eight-month high against a currency basket, while gold prices rose as investors bought the metal to hedge against paper currencies and debt default risks in Europe. Gold futures ended on Friday with a weekly gain of 3.1% at $1,122.10 an ounce.

Gold’s Retreat

Gold had rallied to a record of $1,218.30 an ounce on Dec. 3, 2009, as near-zero U.S. interest rates and government spending weighed on the dollar and countries including India and China boosted gold reserves.

However, bullion in the spot market has declined more than 6% since December, as the U.S. dollar benefited from the unfolding debt crisis in Dubai, Greece and the rest of southern Europe.

New Inverse Tango with Euro

Since gold is primarily a hedge against the dollar and inflation, it typically has the strongest inverse correlation with the US dollar. In the last month, however, the trend has broken with gold trending inversely with the euro and positively with the dollar (Fig. 1). The euro has now taken center stage in dictating the price of gold as it pertains to the fiscal health of Greece and other eurozone countries.

Fears over the outlook for the euro have been driving investors out that currency, and lifted both bullion and the dollar as alternative assets. The euro has declined, particularly against the dollar and gold, almost 5% against the dollar, and gold in euro terms is up 4.2%, so far in 2010.

Mariachi - PIIGS & The Fed

The new trend between the euro, dollar and gold is expected to continue amid fiscal challenges in the UK and Eurozone, PIIGS (Portugal, Iceland, Italy, Greece and Spain) in particular. Uncertainty over the details of any financial rescue package for Greece will likely keep the mood in the markets nervous, and the currency markets volatile in the near term.

In addition, the Fed’s discount rate hike signals that other central banks will likely follow suit in exiting from stimulus measures, while the eurozone, UK and Japan will likely lag behind. This view has partly triggered selling of the euro against the dollar, and some other currencies to seek a positive yield and perceived safety.

These two factors will likely continue to be the major forces driving the euro’s direction for the rest of Q1, and may spill over into Q2 depending upon solutions to the Eurpoean Union`s debt problems and dearth of future growth opportunities.

Technicals - Short-term Mixed

Technically speaking, the short term indicators of gold are mixed and still trending bearish as gold prices remains in the lower part of its recent trading range.

Technical analysts have widely diverging views as well. For instance, Chartered Market projects gold to reach about $1,400 within 12 months as long as the $1,000 level holds; whereas Barclays Capital considers a “fair value” for gold around the $700 to $800 an ounce level.

Meanwhile, Nouriel Roubini, economics professor at the Stern School of Business, New York University, says that there is a bubble in commodities, and that the price of gold should be no higher than $1,000 an ounce given the current market conditions.

Techincal levels of significance would be a breakout above the $1150 level, which would be bullish; and breakout below the $1050 level of support, which would be bearish for the commodity.  (Fig. 2)

Vulnerable to Rapid Unwind

According to the Commodity Futures Trading Commission (CFTC), NYMEX gold futures open interest increased 3.2% in January. Commercial traders increased their long positions, while holding net short positions. Non-commercial speculators held net long positions but increased their short positions. Overall, about 54% of the participants held net long positions in January. (Fig. 3)

Gold has attractions for those managers of private institutional funds. Many investors from George Soros to John Paulson have been buying gold as lower interest rates and continued money-printing could devalue the U.S. dollar in the long term.

Billionaire fund manager George Soros, for instance, told the financial elite at Davos that gold represented the “ultimate asset bubble”; however, data from SEC filing showed his fund more than doubled the stake in the SPDR Gold Trust (GLD) three months earlier. In fact, the gold trust is now his fund’s biggest investment, valued at $663 million.

The large number of long speculators playing in the Gold market could leave the market vulnerable to a rapid unwinding when sentiment changes – the crowded trade scenario. One can only speculate that Mr. Soros could be seeking to exploit this market vulnerability with his seemingly uncharacteristic and contradictory actions.

Other Market Factors

Furthermore, the gold price direction also hinges on several events about to unfold within the next few months:

1) Greece’s borrowing needs are covered only until mid-March, and is set to launch a new bond offering of $7 billion in coming days – Eurozone/euro could stand or fall on the success or failure of this bond sale.

2) European finance ministers gave Greece a one-month reprieve to show its deficit reduction plan was being rolled out effectively.

3) Dubai World will present a proposal to creditors in March to restructure about $22 billion of debt.

4) The IMF’s phased open-market sales of the remaining 191.3 tons of gold it planned to sell last year as there are no more official buyers – Bearish for gold, unless another central bank steps up.

5) The Federal Reserve will end a $1.25 trillion program of mortgage-debt purchases in March – Gold-bearish as it reduces liquidity.

As ever gold thrives on financial, economic and monetary uncertainty, there is certainly plenty of that in the world today.  Sovereign risk will likely remain the main theme for 2010, and possibly 2011.  This all sets the stage for the next five years of monetary and fiscal policy decisions around the globe which will ultimately define the future for this precious metal from an investment standpoint.

Disclosure: No Positions

Tags: Alternative Assets, China, Commodity Prices, Currency Basket, Debt Crisis, Debt Default, Economic Forecasts, Emerging Markets, Euro Dollar, Europe Gold, Eurozone Countries, Fiscal Challenges, Fiscal Health, Gold, Gold Bullion, Gold Futures, Gold Prices, Gold Reserves, India, Inverse Correlation, Italy Greece, Paper Currencies, Price Of Gold, Southern Europe
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Bill King: Is Gold in a Bubble?

Friday, December 4th, 2009

This post is a guest contribution by Bill King, of The King Report.

A worse-than-expected ADP Employment Change for November (-169k vs. -150k exp) chilled traders’ appetite for stocks. But gold is a different animal, and it’s in a parabolic rise.

Bad news is really good news for gold because it means ‘more juice’.

Several weeks ago, we noted that gold was about 20% above its key 350-day moving average. We opined that gold wasn’t bubbling yet; gold would need to get 40% above the key moving average before it was bubbling. Gold is now (in overnight trading) 34% above its 350-day moving average ($916).

Gold got 40% above its 350-day moving average on May 15, 2006; it fell from 720 to 542 in one month. Gold also got 40% above its key moving average on 3/17/08; it declined from 1032 to 682 by 10/24/08.

Oil got about 60% above its 350-day moving average in 2008…Nasdaq got 75% above in 2000.

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Ambrose Evans-Pritchard: After quietly doubling reserves, China is wary of gold ‘bubble’
The Chinese authorities have given the clearest indication to date that they view the surge in gold to an all-time high of $1,217 (£730) an ounce as a speculative frenzy. Hu Xiaolian, the vice-governor of the central bank, said Beijing would not buy gold indiscriminately.

“We must keep in mind the long-term effects when considering what to use as our reserves,” she said. “We must watch out for bubbles forming on certain assets and be careful in those areas.”
News that the rising powers of Asia are shifting a chunk of their fast-growing reserves into gold in a flight from Western paper currencies has emboldened investors to take out large gold bets on the futures markets or through exchange traded funds, leading to the parabolic rise in price over recent weeks.

However, officials in Beijing are aware that China’s…central bank cannot buy much gold without
distorting the price, so they have adopted a de facto policy of buying in a calibrated fashion each time prices fall back to their rising trend line – “buying the dips” in trading parlance. Experts say that China is putting a floor under the gold price but does not chase rallies once they are under way.

Tags: 916 Gold, Ambrose, Bad News, Bill King, Bubbles, China, Chinese Authorities, Chunk, Clearest Indication, Different Animal, Emerging Markets, Employment Change, Evans Pritchard, Exchange Traded Funds, Fashi, Frenzy, Futures Markets, Gold, Moving Average, Nasdaq, oil, Ounce, Paper Currencies, S Central, Vice Governor
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Bullion – a viable alternative to fiat currencies

Friday, September 18th, 2009

Gold bullion has risen by $105 (11.6%) since its low of July 9, breaching $1,000 a few days ago and now trading at levels last seen at an intraday high of $1,033 in March 2008.

Gold bulls argue that the yellow metal stands to gain from rising inflation expectations as governments engineer the biggest asset price reflation in human history. On the other hand, John Mauldin (Thoughts from the Frontline) is of the opinion the rise in gold does not really tell us anything about the future of inflation. It is his belief that if the Fed were to withdraw from the current economic battle, the forces of deflation would be felt in short order. Mauldin contends the answer to the question “Will we have inflation in our future?” is “You better hope so!” But gold may not be a bad performer in a deflationary environment either as a store of value as the economy sinks into the abyss.

Although the declining dollar has been one of the catalysts for gold’s rise, it is also important to note that gold bull markets are usually characterized by the metal making headway in all currencies. As shown below, this is now happening with bullion rising in terms of most major (and minor) fiat (paper) currencies.

Source: Plexus Asset Management (based on data from I-Net Bridge)

Source: Plexus Asset Management (based on data from I-Net Bridge)

I believe another driver of the rising gold price is China’s loss of confidence in the greenback. The Chinese are more than a little concerned about the large exposure they have to the US dollar (most of their foreign reserve holdings are invested in US government bonds) and have been diversifying into other currencies such as the euro and the yen, as well as gold and other commodities. In fact, it was recently announced that China has doubled its gold reserves to 1,054 tonnes in the last few years, making China the world’s fifth-largest holder of gold, just ahead of Switzerland, and among the six nations plus the International Monetary Fund that have reserves of more than 1,000 metric tons.

According to John Mauldin, the steady rise in gold over the last eight years to the current level has roughly tracked the emergence of China as a superpower in foreign reserve holdings, which now stand at $2 trillion.

In view of all the uncertainty regarding the sustainability of the current improvement in the global economy I am of the opinion that one should have gold in one’s portfolio. The last words go to long-timer Richard Russell (Dow Theory Letters) who summarizes the investment case as follows: “Gold is the standard, it can’t go bankrupt, it will rise in value if the dollar tanks, it will rise in value if inflation takes off, and it will sky-rocket if the US tries to inflate its debts away.”

Tags: Abyss, Asset Price, Bull Markets, Catalysts, Commodities, Declining Dollar, Fiat Currencies, Gold, Gold Bullion, Gold Bulls, Gold Price, Gold Reserves, Government Bonds, Greenback, Headway, Human History, Inflation Expectations, John Mauldin, Paper Currencies, Plexus Asset Management, Reflation, Six Nations
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Byron Wien: Ten Surprises for 2009

Tuesday, January 6th, 2009

Byron R. Wien, Chief Investment Strategist of Pequot Capital Management, Inc., today issued his list of Ten Surprises for 2009. Mr. Wien has issued his economic, financial market and political surprises annually since 1986. The 2009 list follows:

1. The Standard and Poor’s 500 rises to 1200. In anticipation of a second-half recovery in the U.S. economy, the market improves from a base of investor despondency and hedge fund and mutual fund withdrawals. The mantra changes from “fortunes have been lost” to “fortunes can still be made.” Higher quality corporate bonds, leveraged loans and mortgages lead the way.

2. Gold rises to $1,200 per ounce. Heavy buying by Middle Eastern investors and a worldwide disenchantment with paper currencies drive the price of precious metals higher. In a time of uncertainty, investors want something they can count on as real.

3. The price of oil returns to $80 per barrel. Production disappointments and rising Asian demand create an unfavorable supply/demand balance. Other commodities also rise, some doubling from their 2008 lows. Natural gas goes to $9 per mcf.

4. Low Treasury interest rates coupled with huge borrowing by the Treasury send the dollar into a serious downward slide. Overseas investors become concerned that the currency printing presses will never stop. The yen goes to 75 and the euro to 1.65.

5. The ten-year U.S. Treasury yield climbs to 4%. Later in the year, as the economy shows signs of recovery, economists and investors shift their mood from concern about deflation to worries about inflation. A weak dollar, rapid growth in money supply and record-setting deficits (over $1 trillion) are behind the change.

6. China’s growth exceeds 7% and its stock market revives. World leaders credit China’s authoritarian government for its thoughtful stimulus policies and effective execution during a challenging period. The Chinese consumer begins to spend more and save less and this shift is behind the unexpected strength in the economy.

7. Falling tax revenues from the financial sector cause New York State to threaten bankruptcy and other states and municipalities follow. The Federal government is forced to step in and provide substantial assistance. The New York Post screams “When will the bailouts stop?”

8. Housing starts reach bottom ahead of schedule in the fall, and house prices stabilize after dropping 15% from year-end 2008 levels. The Obama stimulus program proves effective and a slow growth recovery begins before year-end. Third and fourth quarter real gross domestic product numbers are positive.

9. The savings rate in the United States fails to improve beyond 3%, as most economists expect. The concept of thrift seems to have vanished from American culture. Peak job insecurity and negative growth drive increased savings early in the year, but spending resumes as the economic growth turns positive in the second half, making Christmas 2009 the best ever.

10. Citing concerns about Iraq’s fragile democratically elected government and the danger of a Taliban-controlled Afghanistan, Barack Obama slows his plan for troop withdrawal in the former and meaningfully increases U.S. military presence in the latter. In a hawkish speech he states that the threat of terrorism forces the United States to maintain a strong military force in this strategic area.

Mr. Wien believes these surprises, which the consensus would assign only a one-in-three chance of happening, have at least a 50% probability of occurring at some point during the year. In previous years, more than half of the elements of the list have proven correct.

Pequot Capital Management is a private investment firm.

Source: Business Wire
http://www.businesswire.com/portal/site/home/permalink/?ndmViewId=news_view&newsId=20090105005763&newsLang=en

Tags: Authoritarian Government, Capital Management Inc, Chief Investment Strategist, Chinese Consumer, Corporate Bonds, Demand Balance, Despondency, Disenchantment, Downward Slide, Leveraged Loans, Overseas Investors, Paper Currencies, Pequot Capital Management, Pequot Capital Management Inc, precious metals, Price Of Oil, Printing Presses, U S Treasury, Unexpected Strength, Weak Dollar
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