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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