Gold: Due for Rally or Selloff?

Once again gold, inflation and the greenback are making a great number of headlines, and investors are viewing the sliding dollar as a reason to buy gold. Is it, or is there more to this than investors are seeing? Let's take a look at some headlines that reveal independently, all the components that investors should bind together for a more informed decision.

There are three components that work dynamically and should be laid on the table for holistic consideration - Currency exchange, inflation concerns, and balance.

First, let's look at the following reports discussing inflation - in between the real news here is the sliding is rising in relation to the weakening dollar. But the dollar is weakening because investors are ditching their risk-free assets in favour of risky assets such as equities, and ... gold. So what you have is a double gain for gold, at least for right now.

Gold Rises to Record Settlement Price on Inflation Concern, Bloomberg, September 16, 2009

Gold rose to a record settlement price on speculation that a global economic recovery will stoke inflation. Silver jumped to a 13-month high as the dollar’s slump boosted demand for metals as alternative investments.

The worst U.S. recession since the 1930s has probably ended, Federal Reserve Chairman Ben S. Bernanke said yesterday. The dollar slid to its lowest level in almost a year against a basket of six major currencies as the economic outlook reduced demand for the greenback as a haven. Gold futures were 1.3 percent below an intraday record $1,033.90 set in March 2008

U.S. Economy: Data Point to Growth Without Inflation, Bloomberg, September 16, 2009

Reports on industrial production and consumer prices today showed the U.S. economy is emerging from the economic slump without spurring inflation.

Output at factories, mines and utilities climbed 0.8 percent last month, exceeding the median estimate of economists surveyed by Bloomberg News, data from the Federal Reserve in Washington showed. The Labor Department said the cost of living climbed 0.4 percent, and was down 1.5 percent from August 2008.

The sliding dollar, which comes as a result of bullishness in the market, as well as investors seeking higher yielding investments, is raising the specter of intervention, particularly in the dollar/yen and dollar/euro, which could possibly hamper a further rise in gold - For the time being then it appears that intervention may not yet be on the table unless some unforeseen event arises:

Robinson Says Dollar-Yen May Fall to 'Just Above 87', , Bloomberg, September 17, 2009

Andrew Robinson, analyst at Saxo Bank says the dollar could weaken further to 87 vs. the yen - he believes that the Japanese, who currently favour the stronger yen, would intervene verbally at 87 and with policy at 85.

Dollar Falls to 2009 Low Versus Euro; Yen Strengthens Toward 90, , Bloomberg, September 16, 2009

The Dollar Index dropped to a 12-month low as the MSCI World Index of stocks advanced for a third day, boosting appetite for higher-yielding alternatives to the U.S. currency. Demand for riskier assets also increased as Japan’s central bank raised its assessment of the nation’s economy. The Swiss franc declined against the euro before the Swiss National Bank’s decision on interest rates.

“People are getting more optimistic and this is driving the dollar,” lower, said Ulrich Leuchtmann, head of currency research at Commerzbank AG in Frankfurt. “With more risk appetite and improved liquidity in the market, people are again looking at interest-rate differentials.”

So the real concern should be on whether we have inflation or fears of inflation. For the time being, as long as the dollar continues to weaken on optimism, gold could continue to strengthen, but these things never occur in a linear fashion. Secondly, if currency balance becomes untenable for any of the three large currencies (Dollar, Yen, Euro) there will likely be an intervention to strengthen the dollar, or weaken the others. Currency exchange related policy is a phantom area of economics subject at times to the whims of central bankers and the IMF.

It seems unusual for gold to be rising along with the equity markets because it defies the commonly held idea that gold is a bellwether of uncertainty, as it comes at a time when optimism seems to be reigning in the market.

From our perspective, this may be a good time to consider rebalancing, to take some of this rally's money off the table in the equity market, in emerging markets and gold on strength.

In the long run, inflation may indeed rear itself, given that trillions of dollars have been printed, but for now, it appears to be a perceived notion.

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