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The US Dollar - the nicest horse in the glue factory - squashes gold

News reports on the internet covering both the gold market as well as the wider economy have taken tones that verge on the hysterical and even inflammatory. The quiet reasoned argument perhaps doesn't cut it in that environment.

The sharp fall in gold prices (always an emotive topic for some) has clearly encouraged exaggerated rhetorical devices or hyperbole like never before so our headline simply joins the rest. Whatever happened to litotes and bathos (look it up, I did).  

What can we say about the recent sharp fall in gold prices - and does it mark a massive buying opportunity or signal the end of the decade long bull run - as many would suggest.

The simple and rather boring truth is neither. Gold does not operate on a random walk and nor for that matter is the market 'managed'. It adhere's to relationships such as the dollar, equities and oil, it reflects the balance of supply / demand fundametals and it echoes sentiment about the broader global economic outlook from time to time (now more than ever).

The gold price fall of the last couple of days will have perplexed and disappointed many as gold evidently failed to uphold its primary role as a safe haven asset - surely now more than ever gold should reflect the deepending economic crisis. Well gold has other relationships - equally strong - which it upholds, in particular is the  one with the US dollar. The dollar index was clearly oversold, it fell to very strong technical support and the dollar has rallied by about 10% on a short covering rally promoting a corresponding fall in gold. The dollar strength of course reflects Euro weakness but also the Indian rupee (which hit a record low against the dollar) and with gold prices in rupee terms record highs, thus crushing demand.  

For me the gold price fall may foreshadow something else at play and this I find more worrying. Clearly gold is currently traveling with risk assets - something it occasionally does - and it may reflect an expectation of a sharp correction lower in equity markets and equally it may reflect a deepening liquidity crisis (and the need for cash) something that many banks and businesses will struggle with.

In short, 2011 has shades of the 2008 Lehman crisis about it in terms of price action where there was a scramble for liquidity (and gold fell) followed by a flight to safety (and gold rallied).

That gold would see some year end profit-taking is not unexpected - and nor should the price volatility surprise us given that the markets are particulalrly thin at this time of year where a little buying or selling goes a long way. Technical factors almost certainly will have played a roll in extended gold's fall as the 200 DMA succumbed and stop loss selling exaggerating the move lower.

The dollar strength may be warranted. There are modest grounds for optimism given that US growth rose from sub 1% in H1 to 2% in Q3 and a hoped for 3% in Q4 - more importantly unemployment has just eased from a rather sticky 9% to 8.4%. Granted that the growth has been stimulus-driven and these roll off at the end of the year and like most stimulants they can be addictive - it remains to be seen how well the US can wean itself off those growth enhancers. With Asia begining to falter it may fall to the US to again provide the engine for growth.

We have not yet counjered our forecasts for 2012 but we think it is wrong to assume the gold bull run is over - between 193 and 1978 gold saw two 20% corrections and a 40% fall - before it went exponential in 1980. As such we are optimistic for gold for fundamental reasons but ongoing dollar strength could take the shine off a more typical 16% year on year gain.

Ross Norman
Sharps Pixley, London

15 Dec 2011 | Categories: Gold, Dollar, US

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