GOLD ANALYSIS

Gold still an integral part of the current monetary system

While the financial world still struggles, gold prices are taking a breather but, good support is expected around the $1300 level

Posted: Monday , 25 Oct 2010

David Levenstein - 

Every single day as the values of currencies, bonds, equities, commodities and gold fluctuate, investors try to determine which sector is going to yield the best returns over the next 3- 5 years. While past performance is no guarantee of future performance, gold has been one of the best performing assets over the last decade, and if one considers the fundamentals driving the gold price, it is reasonable to assume that this trend is going to continue in the foreseeable future.

The gold price is determined by many different factors such as basic supply and demand dynamics, geo-political events, values of currencies....in particular the US dollar, and central bank activity. It does not trade in isolation, and the price fluctuates as does the prices of the various currencies. Since the US dollar peaked in 2001, the relative values of global currencies especially the US dollar have been the main driving force behind the higher gold prices.

Markets such as equities or financials tend to be traded locally during the business day in their own time. For example, Hong Kong traders focus primarily on Chinese stocks while European traders focus on European stocks and US traders on US stocks and financials. While most of these traders keep a sharp eye on what is happening elsewhere as nowadays many of the global markets are integrated, an event is Brazil that directly affects Brazilian stocks may not have the same effect in the USA.  Global currencies or the forex market on the other hand is an asset class that is truly global reflecting every economic development on this planet. Whatever has an influence on currencies in say Tokyo will have an effect on what happens to currencies in London or New York. And, as the values of these currencies change so does the value of gold. It is clear that there is an inter-market relationships among currencies and gold. 

Each country has its own currency to facilitate its business and trade. The value of one currency as compared to another depends on the economic health of the nations involved as well as the perception of stability and confidence in the political climate in those currencies. As conditions change, currency values also change to reflect the new situation. Changes in these currency valuations have a significant impact on governments, corporations, financial institutions as well as individuals. The forex market probably has a more pervasive influence on worldwide economic conditions than any other market. And, gold acts as a barometer for these changes. It is an alternative currency one can hold instead of holding "paper money," or "fiat money," as it is commonly referred to. While gold's value is influenced by the value of the other currencies, it still has an intrinsic value and will never be worth nothing which could happen to any one of these fiat currencies.

Currency prices are effected by a variety of economic and political conditions, and many government reports and other actions have an impact on these markets, some more directly than others. These reports include the Federal Open Market Committee (FOMC) Meetings and the Feds subsequent actions, the Beige Book, GDP figures, Balance of Payments, Employment reports. The US non-farm payrolls released on the first Friday of each month has perhaps the biggest single impact on financial markets. Other data includes inflation, CPI and PPI, consumer confidence, retail sales, Housing starts, Durable Goods Orders, Institute of Supply Management (ISM) index and Business Inventories. Sometimes governments actually participate in the forex market to influence the value of their currencies. They do this either by flooding the market with their domestic currency in attempt to lower the price or, conversely, buying in order to raise the price. Although this is known as central bank intervention, it is nothing other than manipulation.

In the last few weeks we have seen a resurgence of central bank intervention and as the G20 meet in Korea, and despite the rhetoric from finance ministers and central bank governors, I have no doubt that in the future we will see more intervention in the forex market.  With this on the horizon, investors can expect to see the value of their currencies alter dramatically and quickly in the foreseeable future.

Since 2008, and in addition to the usual economic data impacting the values of global currencies, new factors have entered the equation. They include issues of global sovereign debt as well as government budget deficits. Recently, U.S. Treasury Secretary Timothy Geithner said, "It is very important for people to understand that the United States of America and no country around the world can devalue its way to prosperity, to (be) competitive," Geithner added. "It is not a viable, feasible strategy and we will not engage in it." I think it is very important for Geithner to understand that as the Fed continues to debase the US dollar with its program of quantative easing, the dollar will weaken and not strengthen.  This will cause other currencies to rise in value and that may prompt the other countries to take the appropriate action to prevent their currencies from rising any further. A strong currency for an export orientated nation can harmful consequences on exports.

Historically, but not always, the correlation between the price of gold and the US dollar is inverse. So, when the US dollar declines, not only do foreign currencies rise but gold prices also rise. On the other hand, the value of EUR/USD versus gold prices shows a high positive correlation. In other words the value of the euro and gold often move in the same direction suggesting that these markets are both beneficiaries when funds are flowing away from the US dollar. Gold prices act as a barometer for the forex market. As already mentioned, there is a clear inter-market relationship and it is important to see what is going on in one market to determine the likely trend in another.  

My point is, no matter what your local politician tells you, the world is in a shambles. Most industrialized countries have slow GDP growth, high unemployment, huge sovereign debt as well as major budget deficits and interest rates at practically zero. Furthermore, around the world we are seeing rising commodity prices and major currency fluctuations. All this is going to lead to further currency debasement, and possibly both collective and unilateral government intervention in the forex market. We are seeing capital controls already being imposed in various countries and there is a looming threat of a major trade war. The once almost perfect monetary system is now falling apart.

TECHNICAL ANALYSIS

After having broken out convincingly into new all-time highs, the price of gold is finally taking a breather. The market action during the week indicated that there is good underlying strength, and I believe that at $1300 (S1) we will see good support.

About the author

 David Levenstein began trading silver through the LME in 1980, over the years he has dealt with gold, silver, platinum and palladium. He has traded and invested in bullion, bullion coins, mining shares, exchange traded funds, as well as futures for his personal account as well as for clients. www.lakeshoretrading.co.za

Information contained herein has been obtained from sources believed to be reliable, but there is no guarantee as to completeness or accuracy. Any opinions expressed herein are statements of our judgment as of this date and are subject to change without notice.