Gold opened lower this morning amid a global rout in stock prices. After strong gains yesterday, the metal seems to be settling into a trading range awaiting some direction from the dollar. At the moment, Greece has again taken center stage as fears about a default have investors running for the exits in markets across the world. The DOW is off by more than 150 points this session, mirroring drops in European and Asian markets.
These last several weeks have been hard on gold, which is trapped in a short term squeeze between institutional short positions and a flight to safety which is buoying the US dollar. Since reaching new highs earlier this summer, gold has seen some extreme market manipulation (if you can call it that) from major funds which have worked substantial short positions to capture profits as the metal sold off from all-time highs. Simultaneously, the dollar (which is often seen as gold’s counter-play) has been unusually strong on the heels of the crisis in Europe. Simply, the Euro now looks so weak that it is pushing the dollar up in comparison. This has created a short term roadblock for gold prices as they work their way towards $2000 per ounce.
So when will they get there? What will it take for gold to break out of this trading range? These are the questions we’re hearing from investors. Our response: If you want to understand where gold is going and why, stop watching the gold price. It may sound counter intuitive, but today’s price movements in gold are not terribly important to the long term picture. Short term fluctuations may be useful for traders looking to move in and out of the market with frequency. For the rest of us however, the dollar, stock markets, and the general economy are the best indicators of the long term strength and direction of the bull market in gold.
The S&P, along with many major global stock indices, is now officially in a bear market. The employment picture here at home is showing no signs of improvement. Finally, the EU (our biggest trading partner worldwide) is on the verge of collapse. These three facts are the best indicators we have as to where gold will be a few months down the road. Why? Because they determine whether or not gold will have any competition for investment funds.
With stocks now in a bear market, there will be significantly less long term capital flowing into securities in the coming months. This leaves more money on the table, some of which will make its way into the gold market. With 9%+ unemployment entrenched here at home, there is little chance the US budget picture will improve in the coming months. This means that the dollar will remain under pressure when these short term flights to safety begin to subside. A weaker dollar means higher investment demand for gold. Finally, with the EU now engaged in a life and death struggle to maintain the integrity of their banking system, a major engine for global growth and investment is grinding to a halt. That money also has to go somewhere.
Finally, it’s worth noting that Ben Bernanke, testifying to a congressional joint economic committee this morning, said the Fed “will continue to closely monitor economic developments and is prepared to take further action as appropriate to promote a stronger economic recovery...” Most analysts agree that the only “further action” the Fed could take at this point would be more direct bond purchases in the form of a third round of Quantitative Easing. The last two “QE” programs added more than 30% to the value of gold, as investors fear the long term effects the programs could have on the health of the dollar.
Each time stock markets sink, each time the EU teeters closer to collapse, each time the employment picture darkens, and each time the future of the dollar becomes bleaker, gold simply adds to its long term growth potential. A few years back, the fundamentals for gold were really only supportive of prices as high as about $1200 per ounce. That all changed as the global economy continued to deteriorate. Now $2000 gold is being seen as a relative certainty. If you really want to know how high gold prices will go, look to see how much these other economic indicators suffer. Another three years like the last three and all bets are off as to where and when gold will find its top.