Volatility continues
November 04, 2005
Volatility in the gold price is the result of opposing
opinions at work: those who believe the gold price is poised to
rise versus those who believe that the gold price has risen too
much, too fast, and is due for a correction.
The value of gold in other currencies, such as the
dollar, increases in proportion to the inflation rate of those currencies,
and fluctuates in response to changes in exchange rates. In my previous
commentary I mentioned that the inflation rate of the US dollar,
as measured by the increase in M3, has increased rapidly during
the past six months. This increase in US dollar inflation is continuing:
on an annualized basis the increase in the seasonally adjusted M3
numbers for the past month comes to 11.5%.
I previously suggested that the noticeable divergence
of the US dollar gold price from the US dollar exchange rate since
August could be in response to the rapid rise in US dollar inflation,
as the gold price was higher than expected given exchange rates.
If you look at a chart of the gold price you will
notice that even though it was volatile, the gold price moved sideways
for the first half of the year. Then from mid July to September
the gold price rallied but stalled since then, with a noticeable
increase in volatility.
In the chart below a decline in the US dollar exchange
rate is shown as an increase in the Dollar Index*. The increase
in the gold price during July and August can be explained by weakness
in the US dollar exchange rate: the dollar weakened by about 4%,
while the gold price strengthened by about 4%.
However, the subsequent increase in the gold price
is not a result of a decline in the US dollar exchange rate. The
increase in dollar inflation could be at work here, augmented by
something else: the gold market may have anticipated further weakness
in the dollar. We have seen several examples of the gold price moving
in advance of the dollar lately, most notably the day before Ben
Bernanke was nominated to succeed Alan Greenspan.
From the above chart we can clearly see that the dollar
did not continue to decline. If indeed the gold price did rally
in anticipation of a further decline in the US dollar then the gold
price could fall back to around $435 an ounce.
It’s impossible to know how much of the increase
in the gold price was due to dollar inflation and how much was due
to speculation on a decline in the US dollar exchange rate that
did not materialize, so it’s impossible to set a short term
target for the gold price.
As I said in my previous commentary, I am not concerned if the gold
price declines because I think it is ultimately going much, much
higher. Any material decline in the gold price is, in my opinion,
a buying opportunity (sorry for the cliché). But if you are
not prepared for declines then you might panic, and sell exactly
at the wrong time.
Speaking of time, as much as I believe that the US
dollar exchange rate is still going to fall considerably there is
no way to set up a time frame. Successful investing requires patience.
Manage your affairs so that time is on your side -- you will sleep
better at night and have more fun during the day.
Paul van Eeden
Paul van Eeden works primarily to find investments
for his own portfolio and shares his investment ideas with subscribers
to his weekly investment publication. For more information please
visit his website (www.paulvaneeden.com)
or contact his publisher at (800) 528-0559 or (602) 252-4477.
Paul van Eeden works primarily to find investments for his
own portfolio and shares his investment ideas with subscribers to his weekly
investment publication. For more information please visit his website (www.paulvaneeden.com)
or contact his publisher at (800) 528-0559 or (602) 252-4477.
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