Gold prices continue to soar behind the decline in U.S. dollar

The price of gold surged sharply last week and traded close to the $1400 an ounce level. The yellow metal climbed by 3% in New York on Thursday as the dollar slumped a day after the Federal Reserve unleashed a second round of monetary easing. Even though the week was filled with news that would usually have some influence on gold prices, the main driving force behind gold's surge in prices was the announcement made by the US Federal Reserve.

The upsurge in gold prices followed a volatile Wednesday as investors awaited the Fed's news. On Wednesday, the Fed announced its plan to buy $600 billion of U.S. government debt over the next eight months in a bid to stimulate the struggling U.S. economy.

Last week the US mid-term elections had practically no impact on the markets nor did any of the decisions taken by various central banks. The ECB left the main refinancing rate unchanged at 1%. The RBA unexpectedly raised the cash rate by +25 bps to 4.75%, and despite numerous rumours that the BOJ would accelerate easing measures after it brought forward the date of the November meeting, policymakers only disclosed more details on how it will invest money in an asset-buying program announced in October. BOJ's inaction to Fed's $600B QE plan indicates policymakers are not worried about its impact on Japanese yen.

The US non-farm payrolls released on Friday showed that non-farm payrolls rose by a greater-than-expected 151,000 last month. In addition, September numbers were revised to show that payrolls fell just 41,000, far less than the forecast of 95,000 job losses. However, despite these positives, the unemployment rate failed to move down and remains at 9.6%.

Often I have spoken about the global monetary and currency crisis we are currently in the midst of despite government rhetoric to the contrary. And, it is my firm belief that these expansionary monetary policies are not going to help unemployment nor are they going to resolve the current crisis. Instead what will happen is that they will debase the values of currencies, in particular the US dollar. And, as this happens, the value of gold will continue to increase.

Recently, Felix Zulauf, Zulauf Asset Management president, in a Barron's interview said. "The dollar is going to be debased in a major way, and that's reflected in a rising gold price. ... If it remains within conventional boundaries, then I think $2,500 within the next two, three years is possible. Most likely it will eventually get outside of conventional boundaries when the situation worsens, and then it can go much higher in terms of U.S. dollars."

In a recent interview with Reuters, Bill Gross, the manager of the world's largest mutual fund said that the dollar is in danger of losing 20% of its value over the next few years if the Federal Reserve continues its unconventional monetary easing. "I think a 20% decline in the dollar is possible," Gross said, adding the pace of the currency's decline was also an important consideration for investors. "When a central bank prints trillions of dollars of checks, which is not necessarily what (a second round of quantitative easing) will do in terms of the amount, but if it gets into that territory-that is a debasement of the dollar in terms of the supply of dollars on a global basis."

If Gross is correct and I am inclined to agree with him, then I think that if the US dollar loses another 10% from its current value, we could expect to see the price of gold trade over $1700 an ounce. But, I don't think it will take a few years. I see it happening next year.

The current financial crisis will lead to an increase of national debt no matter what remedies the various governments take. Unemployment and bailouts will cause public debt to explode, which will lead to drastic cost cutting programs or the introduction of new taxes or even increases in current tax rates which will in turn only perpetuate this downward cycle. And, as the debt gets larger, and governments become unable to fund their debt, the monetary system will implode. When this happens anyone sitting on a pile of cash will suddenly be left with a pile of pieces of worthless paper. In Zimbabwe the government issued a one hundred trillion dollar note that could not even buy you a decent size loaf of bread. People who had saved their entire lives to enjoy a comfortable retirement were totally wiped out, while Mugabe the person responsible for the demise of the Zimbabwe dollar remains unaffected. I sincerely hope that this does not happen in the USA.

In the fiat monetary system the national currencies of countries have no intrinsic value as they are backed by nothing unless you consider political promises as being a "tangible."

Governments around the world are bankrupt and politicians are out of ideas and are quickly running out of time in dealing with the massive amounts of sovereign debt hanging over the global economy. As governments and central banks continue the cycle of printing more money, the purchasing power of their currencies is constantly being degraded. And, as in the case of Zimbabwe, this inflation eventually wipes out the savings and earnings of the people, who have very limited options for protecting themselves against these ravages. One option is to convert their fiat currency into something out of reach of central banks and government spending, such as gold or silver.

Politicians will never admit to a default on sovereign debt because it would send the country's interest rates soaring, causing the cost of servicing the debt to spiral upwards and ultimately become impossible to finance. However, the issue of debt creation will eventually have to be resolved as it does not merely disappear. And, when governments can't finance their debt the only remaining option is to depreciate the currency in which the debt is ultimately paid back. The effect of this will be to decrease your wealth. For example, in 2001 if you had $100,000 in your bank account, today it is worth around $65,000 in terms of purchasing power. If you had invested your $100,000 into gold in 2001, today it would be worth around $560,000. Simple mathematics tells me that I would rather be in gold than in cash.

Look for gold to outlive the dollar, writes Tocqueville Asset Management managing director John Hathaway in an article for Bloomberg:

"The world's monetary system is in the process of melting down. We have entered the endgame for the dollar as the dominant reserve currency, but most investors and policy makers are unaware of the implications. "

In many of my previous writings I have warned investors of such a scenario, but I have also stated that I do not see a total collapse in the monetary system as we currently know it. In any event, the situation is dire and the result could be similar to what happened in Zimbabwe. In contrast to what the Keynesian economists might have to say about gold, in such a scenario it is important to use the right asset class in order to protect your wealth. Gold is not a typical investment. It is a defence against the predictable behaviour of governments to debase a fiat currency, and historically investing in gold has been proven to be one of the best ways to protect your wealth.

TECHNICAL ANALYSIS



The primary long-term trend, as well as the medium and short-term trends, are all positive. The price of gold has now established good support at $1320/oz (S2) and is in the process of building support at $1360/oz (S1). The price is now in uncharted territory, but it seems as if the next level of resistance is $1400/oz.

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.

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