Gold: Breaking the Rules?

The inverse link between Gold and the Dollar isn't written in stone...

INVESTORS ARE so used to looking at gold rising when the Dollar falls, that the concept of gold rising when the Dollar rises seems to break the rules, writes Julian Phillips of the Gold Forecaster.

We have often commented that there is no rhyme or reason why the Euro and Gold Bullion should move in step with each other versus the Dollar. And yet they have both been driven mainly by Comex derivatives speculators for well over a year now.

Just read most daily commentaries and you will see this link to an inverse path to the Dollar given as the main reason why gold moves. Now the Euro is sending out distress signals, however, and capital is fleeing the European currency. This confirms a trend we have been highlighting, that capital is fleeing from troubled currencies, rather than selecting the US Dollar as the place to be.

We have pointed to the Yen, to the Pound Sterling, and alerted Gold Forecaster subscribers that other currencies also face such capital flight. They turn to the Dollar – the reason for the Dollar's recent rally – because it is the world's prime currency and one at the moment less in danger because of this role.

But be careful, the fundamentals of the Dollar are also pointing to trouble. When the crises really hits, all currencies – unless isolated as perhaps the Yuan is now – will become volatile. The weakness of the Euro is warning us of structural dangers facing the paper currency system itself.

A stable global money system requires nations cooperate globally and don't put national interests first. This will not happen so long as there are so many countries, separate interests and separate economies in the world. The attempt by the Eurozone to integrate so many of these politically, economically and culturally separate sovereign states was bound to suffer structural damage when a rough storm hit.

And now you can see the gold market reacting as it moves up, while the Dollar is holding ground at $1.40 to the Euro. Fixed exchange rates failed because of these differences, so why shouldn't one currency – overlaid as the Euro is – fail too?

Take the floating exchange rate nature of the system, and ask why should an economically strong nation have to suffer a rising currency that reduces and could eliminate its competitive export strength? You can be sure that if the Deutschmark was resurrected and Germany went alone, the exchange rate would price German goods out of the market despite the quality of its goods. When it was around, the signal it was going to revalue was when its Finance Minister denied it was going to revalue!

Don't think for one moment that the Chinese Yuan is going to willingly suffer a similar fate. We are now at the point where we must conclude that 'fixed' exchange rates don't work and 'floating' exchange rates won't work, or should we say, "are not in national interests".

We have made mention of the imminent de-coupling of the Gold Price from the Dollar in the last few issues, saying it had to start with a rise against the Euro, and then against the Dollar simultaneously. We are starting to see that now in the market, but much more work has to be done before that is accepted by Comex Gold Futures market and the like, but happen it will, as a potentially huge move into gold by the largest institutions and bodies of wealth is moving to start the process.

Consequent to European central banks ceasing to sell Gold Bullion – while other central banks on the other side of the world have begun buying it – it is now in most nation's national interests to hold the gold they have in the face of the worst storm the currency system will ever see. As a matter of prudence, gold is being acquired quietly, but in volume.

Particularly of interest is the large covering of short positions we are seeing on Comex. If this continues we will have to ask whether J.P.Morgan et al are making moves ahead of President Obama's moves against the banks trading with other than proprietary funds on their balance sheets? Such a move would be far larger than the process of de-hedging by Gold Mining companies we have seen over the last few years.

What is happening in the Eurozone, to the Dollar, and alongside the shift of wealth to the East, is a build-up in both volatility and credibility of the currency system itself. With national interests so strongly entrenched, globalization is a sitting duck in times of stress. In its place we will see protectionism manifest itself in the monetary world first, via measures to 'manage' the exit of capital from vulnerable nations. At its worst we will see stringent Exchange Controls implemented as part of this process somewhere down the line. But the instability such will bring, will take gold to the level of respect that it used to have.

The reasons why will then scream at us. Gold is untainted by national interests and is an internationally respected measure of value that is being recognized more by each passing day.

It is not simply a matter of past inflation being recognized in a higher Gold Price. Future credibility loss, associated risks outside of inflation still have to be factored into the Gold Price. Then add potential to past inflation to the price and what do you have?

Consequently, there are far too many reasons why gold should move independently of both the Dollar and the Euro.

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