Gold's Euro-Dollar Split

Now broken again, the long-lived Euro-Dollar link with the Gold Price was never essential to start with...

IT'S ALWAYS hard to be weaned off what you thought was a reliable formula for second-guessing the Gold Price, writes Julian Phillips of the Gold Forecaster.

Getting the inside track used to start with the oil:gold relationship. Many traders tried to use it as a measure of the future direction of the Gold Price. But now the second, and longer lived relationship has broken down – and the Euro-Dollar exchange rate may no longer dictate the direction of Gold Prices. Continuing to follow this line will shortly prove very expensive for traders in Comex Gold Futures and elsewhere.

As you can see from the chart of Euro Gold Prices since 2001, and particularly from 2005 – when it became apparent that European central banks were faltering in their determination to sell gold from their vaults – the Euro price of gold began to rise. But this was nowhere near enough to halt the link of the Gold Price to the Euro. Even today short-term moves come about by a move on this rate. This will only slowly diminish as the crises facing both the Eurozone and the US Dollar increase in severity. We are seeing an acceleration of that now, with Greece's problems persisting and Spain waiting to enter center stage.

Why did the relationship between the Dollar, the Euro and the Gold Price come about?

The Euro was formed in 1999, because the exclusive use of the Dollar in all global transactions became unsatisfactory. Under its wing the currency should have united, at least financially, most of Europe. After all it should have reflected the economy of Europe overall, whereas the US Dollar reflects the economy of the US (even though it is used in most global transactions) and is irrelevant to that of Europe. So another global trading bloc introduced its currency independent of the Dollar (bear in mind that the Dollar was not replaced in Europe, local currencies were), one large enough to set up an alternative measure of value.

Since then, the Euro's value against the Dollar has moved from 1:1 to 1:1.5 at its worst. This is over 10 years, and it reflects the profligacy of the US currency, highlighting that the US has been paying bills (measured by the extent of its Trade Deficit) with currency and not goods. (Only a balanced trade account would do that.) This pattern becomes abnormal when it goes on and on...and no effort is made to correct matters, as is the case in the United States.

So it seems fair that a bloc like the Eurozone – with a healthy balance of payments – should offer a good measure of the Dollar. Since then little has been done to rectify matters, hence the steady ongoing decline of the Dollar against the Euro.

But now the Euro is losing its reliability as a constant measure of value, due to worries about particular parts of the currency zone. When the Eurozone was conceived, no room was made for a loss of sovereignty. The Union was united for trade and finance alone.

Yes, there is a European Parliament, but national government and national interests will always be preferred to Eurozone interests. The problems facing Greece (and in the future Spain, France, et al) will mature to bring down the Euro in time, we believe.

After all it was benefits to each nation that brought them all together. Becoming like the States, under one government, was not considered.

With a rich, productive, efficient North and a poor tourist-oriented South in the Eurozone, it was only a matter of time before the pressures were felt under one currency. In the past, strong currencies revalued and discouraged the flow of capital from poor to rich nations. As the capital left these nations and their internal inefficiencies rose to the surface, poor nations began to over-borrow – despite the fact that nothing would change in the future.

Thus a crisis was in the making. It's now here, and there is a perceptible unwillingness to support each other in all seasons, but only in fair weather. Trouble is, the pressure will grow under one currency, not diminish.

There never was a good case for the link of the Euro to the Gold Price. But it has taken internal national problems within the zone to knock confidence in the currency, making this disparity visible. Looking ahead, it would seem that the Eurozone's problems will not go away until there is a mechanism for leveling the playing fields between rich North and poor South. Don't think for one moment that the rich will give handouts to their poor brothers in the South to achieve this on an on-going basis. The Southern nations are breaking Eurozone entry rules and must pay the penalty!

How can the Euro bear up under these "fixed currency" problems? In short, it can't. As for the Gold Price, it must walk its own road, no matter whether the Euro or the Dollar is rising.

A trip back to basics is needed here. What common ground does gold have with the either the Dollar or the Euro? Gold has no politics, it has no nationality, but it does have a respected value when times are dire. Paper currencies lose value in these times. Ask yourself, why did President Roosevelt deem it necessary to confiscate gold in 1933...and then devalue the Dollar against it in 1935 (apart from engineering the acquisition of foreign held gold)? Because as former Fed chairman Alan Greenspan put it in his early days, "Gold is money in extremis."

In wartime all nations and governments respect gold, and it measures value too, even when it is not a means of exchange. The skill is in determining when extreme times are with us. Bear in mind the war did not start until 1940 in the US, but the gold confiscation measures were taken after the Depression and America's banking crisis had been going for four years.

Today's pattern may well not be too far short of that – and in place of a rising Germany, economically, you now have a rising China. Look back to the end of last century (1999) and then at now. Haven't times changed?

At the moment, as the Dollar rally falters and the Euro weakens, a strange stability is given to the Dollar-Euro exchange rate as they glide down together. The behavior of the Gold Price is beginning to testify to that. But as slow as a tidal change is to the sea, with the waves keeping up their constant coming and going, so the institutions and traders in the gold market will move away from the Dollar-Euro link.

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