Wednesday, July 21, 2010

Unstoppable Force Versus Immovable Object: Road To $6500 Gold Paved with Failing Economic News

Kitco has some excellent commentaries.  Darryl R. Schoon discusses the likelihood of a meltdown in the dollar.  He argues that the 1971 devaluation of the dollar and removal of the international dollar from the gold standard led to a fiat currency.  He claims that traditionally fiat currencies last about 40 years, and we are now 40 years into the paper dollar regime.  The result has been trade imbalances, exodus of manufacturing from the US, and inflation. The paper dollar will become worthless in his view and the reverse will occur for hard assets. The collapsing dollar will lead to volatility and the markets will find a stable replacement for the dollar, likely gold or silver.  He predicts $3,000 to $10,000 gold.  He also argues that gold is no more volatile than tech stocks. Schoon claims that there are five stages of a gold bubble and we are in the fourth stage, where there is increased volatility.

Although I don't put much faith in the Fed or Chairman Bernanke, his message suggests volatility indeed.  Before I summarize his speech as depicted in Bloomberg, notice that silver has lagged gold and that commodities like agriculture and the general commodity index have not increased to the same degree.  One claim may be that current demand for gold is caused by its monetary qualities, that some investors are now viewing gold as money.  However, it is also true that the dollar has gone through a period, in my opinion a temporary period, of strengthening. The dollar has gotten stronger because of risk aversion directed toward the global credit and banking collapse (especially including Greece, Portugal and Spain) and because of the collapse in bubble credit here in the US.

Bernanke's talk today as reported in Bloomberg led to nearly a one percent fall in the Dow and the S&P 500. Bernanke indicates that the Fed is planning to raise interest rates, which will have a depressing effect on the stock market.  Bloomberg quotes Dean Maki, chief US economist at Barclay's Capital:

"'The Fed is not close to implementing additional stimulus.'  Expectations for additional steps were based on 'more hope than fact.'"


There is little doubt that the Fed will keep interest rates close to zero.  But continued weakness in the economy creates a logical problem.  If the Fed stimulates inflation increases.  Stimulus also fuels the short-run gold price.  Bernanke aims to begin reducing the amount of stimulus to avoid these risks.  But he risks further increasing unemployment.  The unstoppable monetary collapse meets the unmovable decline in the US economy.

Mr. Schoon is right that in the long term the current monetary regime will fail.  However, international risk and a weak economy suggest a short term strengthening of the dollar.  This could mean fluctuations of gold of 50% or more.  Ultimately, though, the Fed's "printing press" will cause the dollar to crash.  This will result in increasing commodity prices.

If you are worried about long term monetary instability, commodities other than gold might be better holdings right now.  For example, the DBC, Dunn & Bradstreet Commodity Index and the DBA, Dun & Bradstreet Agricultural Index, have hardly risen since 2008.  Moreover, silver, which can be purchased through SLV, the I-Shares silver trust, can be purchased to take advantage of silver's monetary characteristics.  The claim that gold's price increase is due to its monetary characteristics rather than short term speculation is contradicted by the relative lag in silver's price increase.  If you are hedging for a monetary skid or collapse, SLV might be a better bet than gold for now.

Over time gold will go up.  But if you can buy it at $950 why buy at $1180?

6 comments:

Doug Plumb said...

What do you think of Bob Chapman ?

(International Forecaster)

Mitchell Langbert said...

Doug, I haven't followed Mr. Chapman in the past, but a quick look at his site suggests that he is a valuable resource:

http://theinternationalforecaster.com/International_Forecaster_Weekly

I plan on reading his material more closely. Thanks.

Doug Plumb said...

I thought you would like him.

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