A Less Myopic View

Here's a better way of looking at the gold price...

WHAT IS REALLY happening to the Gold Price? Let's look at the Euro Gold Price for some illustration, writes Julian Phillips at GoldForecaster.com.

As I write, the Euro Gold Price stands at €1,030.41 ahead of the Gold Fix. It has pulled back from €1,041 over the last couple of days and still is far away from its peak at €1,065.

However, across the Atlantic in the States, the Dollar continues to fall against the Euro. Consequently, the Gold Price is higher in Dollars, at $1,507.65, but lower in the Euro, before the first London Fix. 

The London Fix continues to dominate the Gold Price in both currencies and accurately reflects London and Asian demand. The London afternoon Fix continues to reflect both European and US demand for physical gold and the main global open market supply of gold. Prices outside the Fixes reflect the local conditions of each market where they are quoted. Physical supplies for those markets usually come either direct from individual suppliers or from London. 

Some US investors can struggle with a global view of gold and silver markets. Gold is seen as having a pre-dominantly Dollar price, whereas the Euro price of gold more accurately describes demand and supply. 

US investors are excited by record US Dollar prices and fear they may fall back. But record US Dollar prices are not due to record gold demand but to the falling Dollar. A record price in the Euro was seen a while back at €1,065. Should the US Dollar fall to $1.50 against the Euro we would expect to see the Dollar price of gold stand at $1,597.50 if gold were to merely equal record Euro prices. If the Dollar continues to fall, the Gold Price will move up through $1,600 and more, without moving up at all in the Euro.

Until US investors adjust to these realities, we expect only the more globally focused US investors to value gold as a protection against a falling Dollar. The global viewpoint will look at the Dollar as just another currency, albeit the world's main one. With its structural problems, it has virtually ceased to measure value. It is now both the tool, as well as the consequence, of the US monetary authorities. 

There is no doubt that the US stands to gain considerably in international trade if the Dollar continues to fall. With the falling Dollar, the price of US goods in foreign currencies falls too. The negative Trade Balance of the US has been a fact of life for more than a decade and is unlikely to return to a surplus, because US manufacturing has been outsourced to places like China and other parts of Asia.

This remains a structurally unchangeable fact until US wages – measured in foreign currencies such as the Yuan – are cheaper than foreign wage levels. No doubt then US manufacturers will then want to relocate back home. By then, Asian manufacturing companies will be so entrenched that US companies will find it difficult to compete with the people they taught. The Dollar has to tumble considerably more for this to be even remotely attractive to US manufacturers.

The Dollar will, I expect, depreciate much further, as a consequence of loose, US-focused monetary policy and a near complete disregard for the Dollar's international role.

That will be the case if other nations' monetary authorities permit it, and don't try to undermine their own exchange rates (and if they do undermine them, currencies will cheapen together, making precious metals still stronger). 

By implication, a global reserve currency has to remain relatively stable. It has to define the value of products in a reliable enough fashion to provide sufficient profits for businesses to continue.

 An unstable declining currency clearly fails to do that. It will eat profits up – often between 5% and 30% of price. 

For instance, a price set when the Dollar was at $1.25 to the Euro may incorporate such margins. If it falls to $1.50 against a Dollar-priced product, the entire margin disappears. Meanwhile, where an exporter prices in the Dollar, which is usually the case, and buys forward exchange rate cover to protect his margins, his contract costs will rise to reflect the instability of the Dollar and his costs creep higher and higher over time. This makes manufacturing an exchange rate gamble or extra cost to his business that raises prices. 

He does of course have the option of not using the US Dollar in international trade. But this lowers the use of the Dollar in international trade, eventually lowering the exchange rate of the Dollar even more.

We believe that the current myopic way of focusing only on the Dollar Gold Price will continue for a while still, until there is a shock that will force a more global perspective. It may happen slowly or suddenly. The earlier investors arrive at this viewpoint, the greater the profits they will make out of the precious metals and the more effectively they will protect their existing wealth against a falling Dollar. 

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