Gold prices held near $1590 per ounce today even as the dollar gained against its European and Asian counterparts. A bleak outlook from across the Atlantic has combined with Fitch’s downgrade of Japanese debt to drive the dollar decisively higher. Three weeks ago, a move like this for the greenback would have driven gold prices down sharply. Over the last several trading days however, gold bugs have started to see a little light at the end of the tunnel.
Three of the last four trading days have seen gold push marginally higher even after a significant run last week left prices vulnerable to profit taking. Several factors have contributed to gold’s stability, including robust physical demand in the mid $1500’s and the recent clearing of a large number of speculative long positions.
What may hint even more to a turn-around in gold’s recent fortune is the fact that prices have managed to maintain and even increase despite a negative posture from outside markets. More specifically, gold has lost much of its appeal as of late due to the fact it’s been trading essentially in tandem with equities. When gold moves with stocks, it tends to lose favor with protectionist buyers who make up a significant portion of investment demand. Over the last several days however, gold has managed to make up ground even on “risk off” days when stocks are down and the dollar up. The shift back to its traditional role as a safety play is absolutely crucial for the future of gold prices, and that may be what we are beginning to see now.
Let’s be clear though that gold is not out of the woods yet. With the ongoing problems in the euro zone, there is little doubt that the dollar will hold its ground well over the next several months. Still, we recognize that the gold market is acting unnaturally in that it has been moving opposite risk perceptions. As we have said all along, this is not sustainable and it will not last. For gold investors who are currently on the sidelines, the question comes down to timing.
Though market intervention on the part of central banks across the world has made it increasingly difficult to predict the swings, we do have a strong comparison in gold’s performance through 2008. Just like this year, gold suffered from the effects of a strong dollar and a fledgling Euro and began a long corrective phase in March of 2008. It fell from a high of $1011 in March all the way to $713 in November before it finally turned around. That correction lasted eight months, and was followed by a virtually uninterrupted run to over $1200 over the next 12 months.
The similarities between the 2008 market and the current one are striking. Gold fell out of favor as investors rushed into treasuries in the wake of the banking crisis, driving the dollar higher against its rivals. The dollar index ran from 72 all the way above 86 before sliding once again and allowing gold to regain its footing in 2009. Similarly, the dollar index moved from around 72 to above 82 in the last seven months, which has artificially suppressed gold prices the exact same way it did in 2008.
Now it’s important to recognize that May is the eighth month of gold’s corrective phase. If we follow the pattern from four years ago we would expect gold to start showing strength in the face of negative outside markets, just as it did in November of 2008; the eighth month of its last correction. That’s exactly what we are beginning to see now.
Through all of this, there is one fact that cannot be forgotten about the US dollar: No matter how strong it looks in the short term, it’s riddled with problems over the long haul. With no end in sight for US debt problems, the dollar is simply not sustainable at these levels and the markets know it. Just as it did in 2008, dollar fatigue will set in at some point and investors will begin to move away from US treasuries. When this happens, it will pop the lid off of gold prices, just like it did in 2008.
After gold completed its corrective phase four years ago, it increased in price by approximately 70% in twelve months. This represented the single strongest period of sustained growth in the history of the modern gold market. Such a move from this month’s lows would put gold over $2600 per ounce by this time next year. Perhaps that’s why so many major banks and firms have left their $2000+ price targets in place. If they are right, it’s just a matter of time.
Mike Getlin is Executive Vice President of Merit Financial, home to America's fastest growing physical gold IRA company. Please send comments or questions to firstname.lastname@example.org.