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Jon Nadler

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I Have A Bon(us) to Pick With You

By Jon Nadler       Printer Friendly Version Bookmark and Share
Mar 16 2009 4:45PM

Good Afternoon,

Gold prices continued their light retrenching on Monday, as investors cautiously diverted some funds into equities following determined statements from various G-20 summit attendees in Brighton. The prelude to the formal meeting of the Group in circa three weeks' time, revealed a united agenda to quarantine and sterilize the pile of toxic assets under which the global economy is gasping for air. The meeting also showed that discord on certain topics remains alive and well however. Take Germany, which is overtly opposed to more stimuli, but is tacitly considering taking custody of the non-performing problem children until they (literally) mature.

New York spot gold prices traded between the same markers as generally seen overnight prior to Monday's session: namely, between $915 and $930 but with a bias to the downside - but not my much - losing $6 at $923.50 per ounce, at last glance. A initial and fairly sharp drop in the dollar (at 86.72 on the index) and crude oil (off neatly $2 at $44.40) coupled with expectations of higher stock market values made for murky early conditions in the commodities pits. Eventually, the buying in stocks abated as these are but tentative steps by early...adopters. The decline in the dollar turned narrower, and oil ended up on the plus side for the day.

Silver ended up with a 26 cent loss at $12.92 per ounce after valiantly trying to keep above $13 for most of the day. Platinum rose $1 to $1056, but palladium dropped $1 to $198 as sideways action in the noble metals continues for a second week. Well, so does, the action in the automotive sector for that matter. No news to bite into. Today's unexpected surprise (from an administration we told you would be full of them) was President Obama's outrage over, and subsequent promise to derail, the bonuses that AIG feels are 'imperative' to pay out.

BULL&#&%. Not in this environment, my friend. NOT with the money of the taxpayers. That's about the essence of what Mr. Obama signaled to the firm today. Welcome to the New World Order. That of populist outrage in action. Disconcerting? Well, so was the wanton disregard for the basics of what people receive bonuses in the first place for.

Ethical business practices.

One thing that appears somewhat disconcerting to us (though it may be early to tell), is the fact that if gold is now becoming positively correlated to the dollar (in the safe-haven sense) then, the question of what happens when the dollar turns lower on investor attention being focused on resurging equities, has to be applied to gold.

In the interim, another weekend of empty gold shops in India, came and went. Prices at local outlets were once again noted to be at a discount to gold available from banks. Buyers are hoping for a range of from $785 to $845 to spark matrimony-related interest among would be in-laws between now and May.

Over in the US, signs of tiny buds on a tree that appeared to be hitherto dying; the US economy. Fed Chairman Bernanke - in a rare televised appearance on "60 Minutes" - opined that, given adequate political 'will' the recession plaguing the US might end this very year. While he sees tentative signs of stabilization, Mr. Bernanke does not envision a full-fledged recovery until sometime in 2010, and even that process will be likely highlighted by continuing high joblessness.

The most relevant aspects of his interview as far as our readers are concerned, was the Fed Chairman's reiteration of the mistakes made in the 30's (letting banks fail en masse, and allowing the money supply to collapse) and the resolve to raise interest rates and concurrently shrink the money supply once things are back on track in the US. "We have to make sure we have a recovery that does not involve inflation." Mr. Bernanke said. With that position, he tried to separate the concepts of reflation versus inflation (not to mention the 'hyper' variety of same).

We had planned to bring you the five sure signs of deflation on the march, but will skip that topic until tomorrow. Here is something else (from the no-agenda site that Minyanville is) you can sink your subliminal contrarian teeth into:

"As an emerging markets banking analyst, James Kostohryz has firsthand experience of banking collapses and their subsequent resolutions in Mexico, Argentina and Southeast Asia. Since leaving his position as Head of International Investments at Brazil's Banco Pactual in 2000, James has worked as an independent trader and investor.

"Dear Professor Kostohryz,

I've been following your comments in Buzz & Banter, and I was interested in your opinion on gold. In particular, I wanted to ask about the correlation between gold and the dollar -- which haven't been correlated for some time -- and why they're now moving up at once. Some people have called this a fear rally driving gold, though now I see a number of people saying it's transitioning to an inflation rally. But can people change their rationale behind a rally that easily and justify increases? It's strange.


To which, the professor replied:

Dear David,

As you may know from the Buzz & Banter, a couple of weeks ago, I sold several gold stocks for a substantial profit. And I assure you, it had nothing to do with the US dollar/gold correlation.

Regarding the ever-shifting rationales cited by many gold “experts? (aka gold bugs) to buy gold, if you've been around long enough, you probably know this is a unique crowd. Among other things, they tend to be highly ideological. To them, everything and anything is a reason for gold to go up. And any decline in gold is dismissed as selling by ignorant people who, at best, don’t “get it,? or, at worst, by people who are part of some conspiracy.

Thus, we'll variously be informed by gold bugs, with great conviction, that if the dollar is down, that’s good for gold; if it's up, it’s good for gold. Gold is good as a hedge against inflation, and it's good as a hedge in times of deflation. If the S&P is going to crash, it’s good for gold; and if it rallies, it's good for gold. You get the picture.

Fundamentally speaking, at this juncture, I don’t think there's anything more to the gold/dollar inverse correlation than the fact that gold is an international commodity. If the value of gold remains constant on a trade-weighted currency basis, then its value in US dollars will decline when the dollar rises against a trade-weighted currency basket.

I say this correlation is of meager fundamental importance because, unlike many gold bugs, I believe that the super-bearish “dollar collapse? thesis is bogus. It's my fundamental view that the US dollar is actually more sound fundamentally than most of the world’s major currencies. If the US dollar ever collapses, other currencies will probably collapse faster and more profoundly than the US dollar.

Thus, gold might be a good investment in an environment in which there's a general crisis of confidence regarding fiat currencies, but it will have nothing to do with the correlation of gold versus the value of the US dollar relative to other currencies.

Certainly, it's possible that at times, there may arise an inverse correlation between gold and the value of the USD against other currencies, and that this movement may be related to the ascendance of doomsday “dollar collapse? theories. However, when such theories become popular, gold will tend to trade up, not only against the US dollar, but against everything else as well, on the basis of generalized fear - and speculation about fear.

To some extent, that was what was happening late last year. Gold was trading up against everything on the basis of general fear of a sharp deterioration of economic and financial conditions.

But, in truth, the specific fundamental basis for the gold/US dollar correlation is extremely weak. And to the extent that the correlation existed, it's because it was merely one indication amongst many others (equity, corporate bonds, CDSs, etc.) of a rise in generalized fear and a rise in systemic cross correlations amongst asset classes.

If one is bearish on the US economy, there are far superior vehicles to trade that hypothesis. For example, you could short equities, buy puts, etc. If you believe the US dollar is going down relative to other currencies, then play the currency markets and short the dollar against the yen or euro. And if you believe that all currencies are going down relative to gold, then buy gold. One has no necessary connection to the other.

Currently, the specific fear of a US dollar collapse has receded a bit, so one would expect the inverse correlation to gold might weaken, and it has. This brings us to another point. I think it's pretty clear that recently, gold has traded as a function of generalized fear (not just US-dollar fear) and speculation about a sharp deterioration in economic and financial conditions.

Look at the up and down days on the S&P and compare it to gold, day by day.

The idea -- propounded by many pundits, such as the ones you refer to -- that gold is currently trading as an inflation play, has little basis in fact. If that were the case, TIPS wouldn’t be projecting long-term below trend inflation. Long-term US Treasuries yields would not be at historic lows. And I could cite many other examples where action in financial markets directly contradicts the idea that inflationary pressures are building or that fears of inflation are building.

So I don’t think there's any real evidence that gold is trading as an inflation hedge. Besides, the fundamental case for inflation rearing its head anytime soon is extremely weak, to say the least. On this point, there are sophisticated ways to measure the “option value? of gold’s inflation hedge. When you perform such an analysis, it will indicate clearly that expectations of inflation have little or nothing to do with the recent dramatic rise in gold.

Gold is best viewed as a vehicle for a peculiar type of speculation. In particular, gold tends to trade as a function of speculations regarding general stress in the economy and the financial system. And one must analyze this within the context of a very particular community that trades gold. Because of this very specific milieu -- and the ideology that tends to drive people that trade in the yellow metal -- trying to find a fundamental rhyme or reason for the movements in gold is often an exercise in futility.

In a very real sense, and in many different ways, intense interest in gold can fundamentally be viewed as a symptom of irrationality. This is a market that's driven by greed, that traffics in fear; it's one where ideological dogmatism tends to reign, and where, as a result, rationality is at a discount. One must keep that firmly in mind when analyzing gold and gold-related markets."

Well, that's one professor's view. Certainly, the positions that came into discussion are plainly visible - everywhere. Unfortunately, so are the defenses adopted by the gold extremists. If you are not with them, you must be against them. This author frequently receives e-mails which are not as much an invitation to discussion, but rather, a platform statement and list of dire predictions. A slew of same can be expected from these views having been aired.

A better solution would be to read and take into account all that which is pertinent to the matter, and make a personal decision based on rational thought. Punditry has a place in the scheme of things; it is just not to be attributed the status of high-priesthood.

Happy Trading Week.

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal



Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.