Don't jump in with both feet yet
May 28, 2004
This is a short note since I just arrived in Toronto on
my way to New York for next week’s investment conference. You should
try and make it to the conference if you can -- it’s going to be
a great event (see sidebar for details). Admission to the conference is
free if you mention that you are one of my readers when you register.
The gold price strengthened early in the week because the
prevailing sentiment in the currency market was that high oil prices would
hurt the Japanese economy. Currency traders who sold yen were, however,
loathe to buy US dollars and settled on euros instead. This drove up the
euro relative to the yen while the dollar-yen rate remained essentially
unchanged. As a result the euro also gained against the US dollar. Gold
traders, who have become accustomed to watching the euro-dollar exchange
rate as a proxy for the dollar in general, bought gold.
It’s smart of currency traders to choose the euro
above the dollar in the short term. I don’t like the euro in the
long term: the European economy is not in much better shape than the US
economy. But I do think that the gold market should be careful of placing
too much emphasis on the euro-dollar exchange rate.
The US dollar has to, and will, devalue against the currencies
of countries with which the US has the largest trade deficits. These are
China, Japan and several other Southeast Asian countries, in addition
to Mexico and Canada, of course. These are the exchange rates to watch,
not just the euro-dollar rate. The dollar has lost about twice as much
against the euro than against these currencies, on average, over the past
week. Until the dollar starts to lose ground against all currencies, especially
those of South East Asia, China and Japan, gold is unlikely to make its
next big move.
On that basis, and because currency traders are still standing
ready to bid up the dollar in anticipation of higher interest rates, I
would have said that this week’s increase in the gold price was
no reason to celebrate. Rather, it created a dangerous temptation for
over-excited gold investors who interpret any increase in the gold price
as the beginning of the next major upwards move.
But Thursday’s trading in the dollar gave me more
reason to be optimistic about the gold price. Apparently currency traders
now think that a modest rate increase is already priced into the current
dollar-exchange rate and the uninspiring economic numbers are casting
doubt over the current economic revival in the United States.
On the face of it, the dollar lost ground Thursday for the
right reason: weakness in the US economy. But currency traders are still
very much focused on interest rates, and they are very willing to shift
capital into higher yielding denominations. This creates the risk that
a higher-than-expected rate increase at the end of June could bolster
the dollar and temporarily take the legs out from under the gold price.
I still maintain that we need to see the dollar weaken in
the face of higher interest rates because higher interest rates will choke
off any chance this economy has of averting a recession. This has not
yet occurred but, as I have explained before (May 14, 2004), I believe
that higher interest rates are a foregone conclusion and so are a lower
dollar and a higher gold price.
So while the activity in the currency and gold markets early
in the week was not based on reasons that could sustain a large increase
in the gold price, Thursday’s activity was more along the lines
of what I expect to see more of, and could sustain a rise in the gold
On balance, however, I am still not convinced that we have
entered the next major upward leg in the gold bull market, and so I remain
cautious. While I don’t like to see my portfolio decline, the longer
the gold price takes to break out (upwards) the better the deals are going
to become. I have started seeing good deals again and, as a result, I
have turned from a net-seller into a net-buyer.
But I am looking for value, not exposure to the gold
price -- I have plenty of that already.
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
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