US Dollar Seismic Shift Hits Gold

By: Christopher_Laird

A month or so ago, we told subscribers that the USD appeared to be bottoming. Long term, the USD has big trouble on the horizon, but we mentioned the USD has 9 lives, even though the US is running terrible deficits, trade and fiscal.

 The Euro had strengthened so much since 2002, and the USD took such a hit, that gold and commodities became hot sectors that attracted lots of money for years. Right now, we are witnessing a big chunk of that speculator/investor froth coming out of gold and commodities. Oil is still relatively resistant. The perception that the USD can recover in a meaningful way is now out.

Also, gold is being sold off to cover margin calls in other commodities.

The advent of the credit crisis caused a gold price explosion, and gold's big spikes since August 2007 tracked credit developments. The credit crisis caused gold and commodities to explode as the central banks threw about $2 trillion, and counting, of lending to prop up their respective financial institutions. The credit crisis has been gold's key market driver since August 07.

Shift of gold market focus now to USD

Then, this Summer, a sort of seismic shift occurred, where the US economy had been slowing for roughly a year, and that naturally spilled over to both the EU region, and Asia. The perception recently became that the Euro likely had overshot its rise. After peaking at about $1.60, the Euro turned down when it appeared the EU region was slowing. That scared Euro bulls, and the USD turned back up. The prospect of a recovery of the USD is now the key gold and commodity market driver.

Of course, any new serious development in the credit crisis can cause that to return to the key focus, and a gold rally. But, right now, the credit crisis has switched from being the key gold driver, to the new key driver, the prospects/implications of a USD rally.

Gold and commodities have rallied for years, as the USD fell since 2002, and some of the 30% plus speculator premium is coming out of them. The recent declines of the CRB and gold reflect that.  It remains to be seen if this is only a correction of the gold and commodity market. But midterm, the prospect of a rally of the USD that can last is having its effects.

This USD rally goes back to what started in 2002

What gives this gold and commodity sell off such power is the prospect of a USD recovery in context to the long USD decline since 2002. Enough structural change is happening to the world economy (weakening EU for example which calls into question the Euro's strength), and improvements in US export competiveness suggest that the USD recovery right now has lungs.

The perception that the present USD recovery has lungs means that all the speculators camping out in commodities are having a change of heart about them. Besides, commodities are more of a speculative play anyway, as these are consumed, and not necessarily long term ‘assets'. Since they are consumed, they are susceptible to price pressures that eventually cause them to revert to historic price levels…particularly if there is the economic weakening we see today.

Of course gold is a long term asset, but remember, it is money – and will always reflect what other currencies are doing. Since the USD appears to have had a major change in direction, gold naturally will adjust to the new environment and react strongly to any major sea change in the USD. That is why gold's price reactions in the last two weeks have been so strong. The magnitude of the gold action reflects the perception that the present USD rally is more than a small bump. As money is coming out of commodities, gold is sold to cover margins.

Also, the advent of ETFs caused a lot of new money to come into the metals and commodity complex and increased the price swings, both up and down.

We have told subscribers that the USD appeared to be bottoming midterm for the last month, and that gold and commodities could take quite a hit.

By Christopher Laird
PrudentSquirrel.com

Copyright © 2008 Christopher Laird

Chris Laird has been an Oracle systems engineer, database administrator, and math teacher. He has a BS in mathematics from UCLA and is a certified Oracle database administrator. He has been an avid follower of financial news since childhood. His father is Jere Laird, former business editor of KNX news AM 1070, Los Angeles (ret). He has grown up immersed in financial news. His Grandmother was Alice Widener, publisher of USA magazine in the 60's to 80's, a newsletter that covered many of the topics you find today at the preeminent gold sites. Chris is the publisher of the Prudent Squirrel newsletter, an economic and gold commentary.

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