Gold and the Dollar-Debt Crisis

Can you imagine the Dollar rising and gold falling amid a US debt crisis...?

IMAGINE a sovereign debt crisis being bullish for the US Dollar and bearish for gold, says Dan Denning in his Daily Reckoning Australia.

In fact you don't have to imagine it all. Or be insane. Bloomberg reports that, "Dollar Rises as Stocks, Commodities Fall in Flight From Risk."

February Gold Futures fell below $1100, down 2.5%, late last week. The Dow Jones Industrials fell 1.3% the same day. And the US Dollar rallied against all 16 currencies in the Dollar index. What gives? First a chart...

Above is a three-year chart for the US Dollar index. We put three boxes around clusters of trading activity where the Dollar index broke above or below the high 70s level.

For whatever reason, this is both resistance and support for the index. Right now, if the index can get above and 78 and hold it, you'd reckon the long-awaited US Dollar rally is here and it's going to do some damage to risk assets, including Australian mining stocks and the Aussie Dollar.

This is a point Bill Bonner made when we visited him in South Africa last week. He said, "Stocks will go lower and gold will go higher, but the bear works in mysterious ways. The bear shakes out those with weak conviction. They are suckered in by rising prices and beaten down by corrections."

The Dollar, in short, is suckering in more suckers. Still, it's strange to see the Dollar rallying on risk aversion, as if the Dollar itself wasn't the greatest risk of all. The US Congress raised America's debt ceiling by $290 billion last week to $12.394 trillion and passed another $154 "jobs bill" (which shows you how effective the first one was).

These aren't the sort of things that make a currency stronger. As our friend Jim Davidson said when we visited him in New Zealand recently, "I can't think of a single example of a country that became great or stayed great because of all the money it owed."

It's hard to argue with that. In fact, we've argued before that the global financial crisis has morphed into a sovereign debt crisis. 2010 will be full of nation states discovering their funding model is broken. Last week, for example, ratings agency Standard and Poor's cut Greece's credit rating A-minus to BBB-plus. That is not an improvement.

The Euro and the British Pound and Gold Bullion and nearly everything else fell against the greenback. But we would view these unusual periods of Dollar strength as chances to build your position in alternative investments at a lower average purchase price. Buy Gold stocks when they correct and add to your gold position at lower prices. The Dollar rally won't last forever.

In fact, "When the United States has to fund its deficit through the combination of issuing more Treasuries and printing more dollars, it is inevitable that the Dollar will continue to weaken," said Zhu Min, deputy-governor of China's central bank.

He's a man who'd know. China owns $798.9 billion in US Treasury debt.

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