Expect more volatility
October 21, 2005
I expected an increase in volatility in the gold price,
and that is exactly what we are seeing. The gold price fell almost
2% on Wednesday, and continued declining Thursday morning as I was
writing this commentary. I received numerous emails about conspiracies
and manipulation in the gold market already; the gold price falls
a few dollars and some people are convinced it has to be the result
of manipulation. Markets do not go straight up, and the higher the
price becomes, the more volatile it is going to be because emotions
and expectations become more and more polarized.
I am still confident that the gold price is going
much higher. In fact, due to the recent surge of monetary inflation
in the US, I have increased my target price for gold to $830 an
ounce.
In a previous article (www.paulvaneeden.com/Library/200304%20Gold.php)
I showed that the gold price in US dollars is determined by the
relative inflation rate of the dollar versus the inflation rate
of gold. This is not only theory, but true in practice as well.
For the benefit of those who have not read the article,
the inflation rate of gold is annual mine production as a percentage
of the total above-ground supply of gold. The latter is essentially
all the gold that has ever been mined, since most of it is still
available in one form or another.
The average inflation rate of gold since 1971 has
been about 1.6% per year while the average annual inflation rate
of the US dollar -- as measured by the increase in M3 -- has been
closer to 8%. It is no wonder, therefore, that the price of gold
in US dollars is higher today than it was in 1971.
The gold price in US dollars kept pace with the projected
gold price as determined by their relative inflation rates from
1971 up to about 1995. During the 1990s, the tremendous demand for
US dollars from foreign investors seeking a safe haven from international
currency crises lead to a surge in the US dollar exchange rate.
This increase in the US dollar exchange rate depressed the gold
price in US dollars, but not in most other currencies.
As the US dollar declines, as it has since 2001, the
gold price in US dollars will return to its inflation-adjusted price,
which by my calculations should be above $800 an ounce by now. But
not all of the increase in the gold price will be due to a decline
in the US dollar exchange rate because monetary inflation will continue
to push the gold price higher.
So when I see the gold price decline, as it has this
week, I am not worried.
The gold price increased by more than 13% since July
(prior to this week’s decline) without any decline in the
US dollar to account for the increase. One possible explanation
for the recent surge in the gold price could be the rapid acceleration
of monetary inflation in US. Recall that the average increase in
M3 since 1971 has been about 8% per year. During the past twelve
months M3 has increase by 7.1%; however, if we annualize the increase
in M3 over the past three months it comes to almost 11%, indicating
an increase in the rate of inflation. Regardless of why US money
supply is increasing so rapidly, the effect will be a higher US
dollar gold price.
As I mentioned earlier, incorporating the recent surge
in US monetary inflation increased my target for the gold price
to over $800 an ounce. Therefore, until we see the gold price at
those levels I believe there is upside in the market. However, I
now suggest you read the first paragraph again: as the gold price
increases, gold price volatility will also increase. Predicting
short-term fluctuations in the gold price is a fool’s game;
betting on them is even worse.
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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