Categories: Precious Metals
Topics: General Precious Metals

Gold Up, Dollar Down

The Fed's determination to spark inflation through dramatic rate cuts and extraordinary creation of currency is making gold much more attractive than the dollar as a safe haven.

By Brien Lundin

The dollar is out; gold is in. At least for now.

That last cautionary note is necessary because gold bugs have been premature in betting on gold's ascendancy over the dollar in recent months. As a result, we've learned the dangers of extrapolating short-term events into long-term trends.

With that said, however, it appears that a fundamental shift in investor perception may be underway. It is some indication of how far we've come in this crisis that the Fed announcement on December 16 of a rate cut of between 0.75% to 1.0% (to a target of between 0.25% to 0%!) was anticlimactic. Treasuries had already traded down to those levels in the open market, and only negative rates would be surprising at this point.

But what was impressive in the Fed announcement was a stated determination to massively expand its balance sheet by purchasing debt with newly created money, technically known as "quantitative easing."

Of course, this tactic had been widely leaked beforehand. But the Fed's public adoption of this policy, and its intention to "employ all available tools to promote the resumption of sustainable economic growth," immediately sparked a steep plunge in the dollar and a correspondingly large gain in gold.

A December To Remember

In actuality, however, the leap in gold following the Fed announcement only punctuated a trend that had begun in the first days of December, as the metal began a steady rally from a dip below $750 to levels as much as $125 higher.

What's been behind the big rally? Simply put, the perception that the dollar will be the preferred safe haven during the remainder of this global financial crisis is being blown away by the reality of
exponential currency creation and zeroed interest rates. Looking   back
through the course of this crisis, we've seen periods where the dollar was king, and times when the throne was shared by gold.

During episodes where people feared the global financial system itself was teetering on the edge of oblivion, investors exchanged national currencies, and whatever else they could sell, for the U.S. dollar and gold.

At other times, collapsing asset prices led to desperate rushes to liquidity. Investors and funds needed to raise cash to meet margin calls and redemptions, and they sold whatever they could to raise U.S.
dollars. In these circumstances, gold --- as the ultimate source of liquidity --- suffered deep sell-offs.

In essence, gold was a victim of its own unique position as the ultimate source of value.

Now, however, investors are realizing that gold is a far better safe haven than the dollar, for a number of reasons. Much of the deleveraging may now be behind us, and the financial system has stabilized to the extent that we have not seen the types of mad rushes to dollar liquidity that we experienced in September and October.

Thus, investors can safely sit back and analyze the ramifications of U.S. interest rates at ground zero and the Fed's stated resolve to massively inflate the supply of greenbacks.

Combined with the new presidential administration's plans for extraordinary spending on infrastructure, investors see an obvious recipe for spiraling inflation combined with growing demand for commodities.

Look at it this way: The dollar and gold have been the preferred safe havens during the financial crisis. Now, however, it costs investors
--- significantly --- to hold the greenback, considering low-to-no interest rates and current-to-upcoming inflation.

In contrast, gold is in an uptrend, and appears likely to increase much further as the monetary tidal wave hits and sends the dollar lower.

There's even more to worry about: Faced with their own problems, how long will foreign holders of U.S. dollars and Treasury debt continue to hold on to a rapidly depreciating asset? While outright dumping of dollar holdings seems a bit far-fetched and counter-productive, any decrease in appetite for U.S. debt will only serve to accelerate the slide in the dollar.

Moreover, this would seem to be an advantageous time for strategic, forward-thinking nations (like China) to exchange dollars for gold. I would not be surprised if we see something of this sort, perhaps via a purchase of IMF gold, announced after the fact.

Brighter Days For The Juniors

It's not surprising to see gold's rally have a pronounced effect on gold mining stocks. But now, accompanied by widespread sighs of relief, we're finally seeing a move in gold starting to benefit the junior exploration stocks.

While they are still trading at historic lows by any measure, the juniors have generally rebounded nicely from their bottoms. Still, looking forward, we have to face the fact that many of the relatively cash-poor juniors will not survive the turmoil intact. However, the better managed and financed companies seem poised for recovery as, and if, gold continues to advance.

In this special year-end double issue, we give you our usual tour of the latest developments among our recommended juniors. Plus, you'll find our annual in-depth review of the New Orleans Investment Conference.

As you'll see, even this voluminous issue can only provide a brief overview of the incredibly valuable information presented at New Orleans 2008.  So enjoy this special double issue, and look out for our next edition in early February. In the meantime, I would not be surprised to see gold take a brief break to consolidate the gains from its recent high-powered rally. The thin holiday markets for the rest of the month could see pronounced volatility as gold can be more easily pushed to and fro...but I think the uptrend will survive intact into the new year.

Brien Lundin, Editor, Gold Newsletter

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