This commentary is adapted from a July 12 webcast by U.S. Global Investors titled “The Halftime Report:A Mid-Year Look at Commodities and Emerging Markets.” A replay of the webcast is available at U.S. Global’s website, www.usfunds.com.

When comparing gold to the dollar, we find is that 80 percent of the time, gold and the dollar move in the opposite direction and 20 percent of the time they go in the same direction. Every time they go in the same direction, we hear pundits saying it’s different this time, and in fact it's not.

 

On the chart above, you can see the price movements of gold and the dollar over the past five years. In mid-May 2006, the spread between these two currencies was at its most extreme, with gold over $700 and the dollar hitting what were then record lows against the euro.

With gold up more than two standard deviations over 60 trading days and the dollar down sharply, we saw little upside potential for gold and went to 40 percent cash in our gold funds as a defensive maneuver. It proved to be a successful, low-risk decision -- over the next 20 trading days, gold fell off by more than 20 percent in one of the most dramatic corrections ever as the dollar recovered from its depths. This illustrates the power of mean reversion.

The spread between rising gold and the falling dollar is what signals caution or opportunity to increase weightings in either cash or gold. We prefer never to gamble 100 percent, but rather to be gradual and opportunistic. Under normal circumstances it’s a gradual process to either invest or disinvest in gold. Never gamble 100 percent about which way you think gold is going to go – we believe too much black-and-white decision making leads to suboptimal performance.

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Gold investing is not about timing markets – it’s about managing risk by identifying the patterns of volatility and percentage allocation between different asset classes like gold, oil and cash.

Earlier this year we had lifted our cash level, as you can see, because the gold was up and the dollar was down. Now it appears that could be more effective with less risk to increase the allocation, since the dollar could easily decline further. Despite making new lows, it’s still not oversold over 60 trading days, according to its five-year oscillator.

If you go back to April/May '06 you can see a huge decline in the dollar.  So if the dollar is to decline back to that level relative to today, gold could be back over $700. Using mathematical modeling, gold has been a laggard here and, based on probabilistic analysis, odds favor a rise.

We believe it has about $50 in the upside and $25 risk in the down side if you did probabilities for the next 60 trading days.

There is usually a higher leverage and volatility in gold shares versus the bullion.  And in a rising scenario, gold equities have historically outperformed bullion.  But the critical driver for gold equities -- 93 percent of the price action daily -- is the price of gold. It drives the price of gold equities but there is more leverage both upside and downside in gold equities.

Visit our website, www.usfunds.com, for more research on understanding volatility in our two-part white paper, “Anticipate Before You Participate.”

Please consider carefully the fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. Gold funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The price of gold is subject to substantial price fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. We suggest investing no more than 5% to 10% of your portfolio in gold or gold stocks. The DXY Index provides a general indication of the international value of the U.S. dollar by averaging the exchange rates between the U.S. dollar and the six major world currencies.