Technical Thursdays: The Dirtier the Dollar, The More Gold Shines

Blog entry from July 12th: “Forget Goldlilocks, Think Gold”
Blog entry from April 24th: “Gold: The $1,000 Investment”*

The first chart** shows the performance of the yellow metal versus S&P 500 since July 12th. No question about that call.
The second** is the price performance of Gold since the Gold tracker began trading. So far, so very good.

However, being right is always yesterday’s news. What about now? Is $1,000 achievable? In a word: youbetcha.

A few follow up thoughts:

Since my March 2005 report on Gold, the central argument for Gold has been the US dollar and its diminishing role of the world’s reserve currency. That view not only remains unchanged but is actually accelerating. The debasing of the American currency (via the Fed and its propensity to run the printing press to avoid even the slightest real economic pain) coupled with the strong growth in foreign reserves is driving many holders of dollar denominated assets (US Treasuries, in particular) to think twice (three times, four times?) about adding to a losing position. Yesterday’s ¼ point rate cut, the Fed's second best decision, contributes to the situation.

To leave the Fed funds rate unchanged was the better choice. However, the Fed's intentions are clear - rates are headed lower. And no matter how you slice it, lower US rates only reinforce the downtrend in the dollar. So, while the dollar may be poised for a crowded trade, short covering rally, the mega and cyclical trend is unmistakable: Down and dirty. And the dirtier the dollar gets, the less inclined foreign buyers will be to own more of a poor performing asset and more inclined to diversify their holdings. Witness the rise in sovereign wealth funds. Witness the rise in the Euro. Witness the rise in Gold.

Investment Strategy Implications

The slow, steady crash in the dollar threatens to get out of hand. Heaven help us if it does. And while no one knows what level a relatively non-productive asset like Gold should trade, it is without question that Gold is benefiting from the diversification effects of major buyers of dollar denominated assets.

Conclusion: Up to a 5% position in Gold belongs in everyone’s portfolio for the foreseeable future.

*Scroll down to "Topics Discussed" links to your left to view.
**click on images to enlarge.

Technical Thursdays: Forget Goldilocks, Think Gold

On April 24, 2007, I wrote about Gold and its prospects for a run to $1,000 an ounce. In that blog posting, I referenced the special nature of Gold as an investment vehicle, how precious little of its value resides in its industrial use, and that the primary value in Gold is as a hedge against instability and as an alternative to the US dollar. Given the fact that the geo-political climate has remained quite unstable (see yesterday's intelligence report re Al Qaeda, for example) as well as the prospective further weakness in the greenback (not to mention the white hot growth in Asia that has helped fuel demand), Gold's role as an attractive investment seems assured.



One concern that I hear pertains to the potential supply coming from Aunt Tilly and Uncle Willie as they cash in their jewelry and coins. While this may be a factor to be mindful of, the larger concern resides in the bullion holdings of central banks, as they dwarf the current demand/supply equation. At 9x the current supply rate, central banks could easily flood the market and depress the price of Gold in a heartbeat. While this risk exists, the likelihood of such an act seems quite remote as a catalyst for such action appears to be fairly non existent.

Investment Strategy Implications

Since the ETF tracker began trading in January of 2005, Gold has outperformed the market by a wide margin (see above chart). Over the past year, however, Gold has been locked in a trading range that has all the hallmarks of a high end consolidation. And, in the process, has enabled the 200 day moving average to approach its current price.

For both fundamental and technical reasons, Gold continues to be an excellent asset to own with qualities befitting the uncertain times ahead. The terrorist and other threats are with us for the foreseeable future. Coupled with the dismal performance of the US dollar and a domestic political climate that is both locked in gridlock and likely to become more cantankerous the closer we get to 2008, the prospects of an upside breakout and run to $1,000 is not unrealistic.

Note: To view a larger image of the chart, click on the image.

Gold: The $1,000 Investment

Just over two years ago (March 4, 2005), I authored and published a report titled “Gold Outlook: Buy”. The thrust of the report centered on the view that Gold was an attractive investment as it provided a necessary hedge against global uncertainty and US dollar weakness and that it had a zero correlation with equities and bonds. Since that report, little has changed to alter the view that Gold is a secular buy and the rationale for owning a position remains intact.

Gold is a special type of investment vehicle. Precious little of its value resides in its industrial use. And while most of what is produced ends up in non productive assets such as jewelry, the primary value in Gold is its standing as an alternative reserve currency to the US dollar. Given the sustained and projected US dollar weakness (not to mention an unforeseen exogenous event), Gold role as an attractive investment seems assured.

An investment in Gold is, of course, not without risk. However, the primary risk with Gold is not the production supply/demand equation but the official reserves. As noted in the report, “Perhaps the single biggest risk to Gold is the potential of an added supply hitting the market – particularly from the central banks of the world. As the aforementioned data from the February 28, 2005 Economist Intelligence Unit report on Gold show, the supply available from central banks dwarfs the supply/demand equation. At ten times the supply or demand levels, government and government organizational sales of Gold could have a serious negative effect its price.” The charts and tables in the report illustrate this and other points.

Investment Strategy Implications

Gold represents a 5% position in my Model Growth Portfolio (MGP) and has been a consistent provider of positive returns for the MGP. As a hedge against uncertainty and instability (and the weak US dollar), it is, in my opinion, an investment for the times. Moreover, as a zero correlated asset to equities and bonds, Gold is an excellent complement to anyone’s portfolio.

The only investment decision-making issue I see with Gold is when to increase or decrease the position. The recent increase in the MGP (from 3 to 5%) was made on March 26, 2007 when it was trading at just under $66. At 5%, it is currently at the maximum level allowed in the MGP.

In the coming weeks, I will update the report incorporating new data. Until then, you are welcome to consider viewing the 2005 report.

Note: Access to the report is available only to subscribers. To learn more about our subscription service, please click on the title of this posting or the services link to the left.