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.

Disclaimer

This letter/article is not intended to meet your specific individual investment needs and it is not tailored to your personal financial situation. Nothing contained herein constitutes, is intended, or deemed to be -- either implied or otherwise -- investment advice. This letter/article reflects the personal views and opinions of Paul van Eeden and that is all it purports to be. While the information herein is believed to be accurate and reliable it is not guaranteed or implied to be so. The information herein may not be complete or correct; it is provided in good faith but without any legal responsibility or obligation to provide future updates. Neither Paul van Eeden, nor anyone else, accepts any responsibility, or assumes any liability, whatsoever, for any direct, indirect or consequential loss arising from the use of the information in this letter/article. The information contained herein is subject to change without notice, may become outdated and will not be updated. Paul van Eeden, entities that he controls, family, friends, employees, associates, and others may have positions in securities mentioned, or discussed, in this letter/article. While every attempt is made to avoid conflicts of interest, such conflicts do arise from time to time. Whenever a conflict of interest arises, every attempt is made to resolve such conflict in the best possible interest of all parties, but you should not assume that your interest would be placed ahead of anyone else’s interest in the event of a conflict of interest. No part of this letter/article may be reproduced, copied, emailed, faxed, or distributed (in any form) without the express written permission of Paul van Eeden. Everything contained herein is subject to international copyright protection.