Gold vs. the Fed

What is the price of gold telling us about the world's faith in the US Dollar...?

GOLD FUTURES closed Tuesday this week almost 9% higher for the day. December gold closed above $721 per ounce, while the Spot Gold Price also shot higher. But it lagged at $712.

   The Gold Market, in other words, reckons gold has even shinier days ahead. What will Ben Bernanke, head of the US Federal Reserve, have to say about that?

  
For now, Bernanke is sticking to his theory that there's a "global savings glut". This "glut" has kept interest rates down in America as foreign money flowed into US bonds. Was the Chairman indirectly telling the market in his speech from Berlin that there's no need to cut interest rates when the Fed meets next week (Sept. 18th)? Or was he just being obtuse?

  
Rate cut or no, stock markets are bound to be disappointed. They've rallied as if a cut was a certainty. Even if it is forthcoming, we don't see how it fundamentally improves the prospects for equities. Still, that the Fed would choose to cut rates instead of supporting the Dollar is not that surprising.

  
The Fed fears a Japan-style deflationary recession. The bear market in credit is one key aspect of just such a recession. A bear market in credit not only dries up the money for private equity deals and the commercial paper market; it also restricts consumer borrowing through higher interest rates on revolving credit card debt.

  
You can kiss goodbye to home-equity lines of credit as well. In a real credit crunch, money becomes scarce, and that pushes rates higher for everyone.

  
Cutting rates at the Fed is one way of trying to avoid this adjustment, an adjustment that inevitably comes when credit tightens. That wasn't always the case.

  
"Under a gold standard," one of our Daily Reckoning colleagues in Australia wrote to us earlier this week, "the domestic economy bears the brunt of any adjustment needed. But under a floating currency environment, the currency takes the hit to minimize the impact on the economy.

  
"Floating exchange rates and democracies evolved (loosely) together. Factored into the above probability is that in a democratic system, politicians will sacrifice the integrity of a currency to minimize the damage to the economy...and of course gold will be the winner."

  
That is the first time in recent memory we've seen the words "politicians" and "integrity" in the same sentence! The point is spot on, though.

  
The rising Gold Price may as well be a lack-of-integrity meter, giving us readings on central bankers. There is not much an investor can do about monetary policy. But you can Buy Gold for defense.

  
Both the rising oil and gold price seem to be on to the Fed's game. Tangible assets –things priced in Dollars – are going up as the US Dollar goes down. And not just against the greenback.

  
Gold priced in Sterling just broke a 16-month high. The Euro Price of Gold is now trading [on Sept. 12th] above €511 per ounce – a gain of nearly 4% in the last four weeks.