Gold prices rise more than a dollar devaluation

As we write, the gold price is about to assault the $1,400 level having been $1,332 on Wednesday of this week, a day ahead of the Fed announcement. Against the pound sterling, the yen the Swiss franc and most other currencies the dollar has weakened too. In the days ahead of that announcement the dollar had been wavering between $1.38 and $1.40 against the euro. After the announcement the U.S. dollar fell quickly down to $1.42 against the euro. But then the dollar recovered a little and is sitting at $1.41. Recently gold has again moved in the opposite direction to the dollar, until it ran up in the euro vigorously, so has this now changed again? Can there be more to the rise in gold than just the fall in the dollar? We believe so, because far more than QE 2 happened this past week.

DID THE MID-TERM ELECTIONS AFFECT THE PRICE OF GOLD?

In the run-up to and after the announcements of the results of the U.S. mid-term elections the gold price barely moved. On the surface we can therefore conclude that the mid-term U.S. elections did not affect the gold price. But whether the Republicans or the Democrats won is not an issue for the gold market. What is an issue for precious metals is, can the U.S. government govern in the monetary area sufficiently to invigorate the U.S. economy and should it wish to do so, strengthen the U.S. dollar?

We found the result pointed to an emasculation of the government's power on the monetary front. Far too much of a burden has fallen on the shoulders of the Federal Reserve, an institution with only limited powers to resuscitate the U.S. economy. Government should shoulder that role, supported in this by the Fed. Government does not appear to now have the capacity to resolve the economic problems of the U.S. This tells us that the enormous steps needed to be taken to strengthen the U.S. dollar are not going to be taken, so a fall in the U.S. dollar is widely expected. The difference for the dollar now is that its fall can be precipitous and not simply a repeat of the fall in the last two years. Control over the dollar's value for the next two years appears to have slipped from the grasp of the U.S. monetary authorities. This is extremely positive for the gold price.

DID THE FED ANNOUNCEMENT OF Q.E. 2 AFFECT THE PRICE OF GOLD?

Ahead of the announcement a ‘bear raid' on gold was mounted that had the gold price drop from $1,358 down to $1,332 in a steep dive that shook the weak holders and triggered more than a few ‘stop loss' positions. Ordinarily, this would have been enough to deter investors, but it happened when the market was seeing thin volumes of trade, hence the size of the fall. On the announcement these bears received a very sharp silver coated, golden horn in the sensitive parts and rose like a space shuttle breaking up through the fifties and sixties and on through resistance at $1,370. Right now we are tapping $1,400.

Undoubtedly the activity of buyers looking for physical gold from most gold markets in the world was the primary driver. But add to this the scramble of short covering that is now going on. The short covering comes not only from those who went short ahead of the announcement but from longer-term shorts, realizing that the breakout to new levels is well founded on fundamental factors. The announcement from the Fed established those fundamentals. However, a greater and greater proportion of gold investment buying globally is due to a growing fear of the global currency system itself!

WHAT ARE THE RAMIFICATIONS OF THE FED'S ANNOUNCEMENT?

The entire financial world had been waiting for weeks for the Fed to make this announcement. It was important because it directly affects the value of the dollar inside and outside the U.S. While the U.S. does not intend to cause a devaluation that will enhance the international competitiveness of the U.S., that is what is happening. That is how the rest of the world will see it. They will take action in their own interests to protect themselves. They have to or see themselves suffer as the U.S. has been doing so for some time now. This will have three primary effects on the global economy: -

•1. The U.S. will lose the cooperation it had hoped for with China and other nations who it asked to let their currencies rise but who will now suffer from a lower dollar, such as China. Global monetary cooperation, sorely needed now, will decay. Currency crises in different nations will be inevitable as they each strive to protect their own interests.

•2. Foreign investment capital channeled into the U.S. and badly needed there, will accelerate its diversification from the dollar. This will accelerate the fall of the dollar and see capital exit the U.S. To the extent this happens it will act as a counter to QE 2.

•3. It will undermine the dollar's global hegemony, which in itself will create considerably more uncertainty as to exchange rates and values.

Julian Phillips is a long time precious metals analyst and is the principal writer on www.goldforecaster.com and www.silverforecaster.com

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