With gold selling off about 20 percent in the last few weeks, there appears to be much confusion as to what, if anything, has changed for the bullish scenario. But the truth is not much. Gold is now and always has been a hedge against a falling dollar, which is the result of an inflationary monetary policy on the part of our central bank.
However, despite the fact that Ben Bernanke's best friend is a crumbling currency, the U.S. dollar is currently increasing as measured by the Dollar Index. And so, in knee jerk fashion, investors have dumped gold. But this is sophomoric and egregious reasoning.
The domestic purchasing power of the dollar isn't increasing and there has been no change in the intrinsic fundamentals of the currency either. The dollar is only increasing when measured against the Euro-a currency that is used by several insolvent and imminently bankrupt nations. The reasons for a secular decline in the purchasing power of the U.S. dollar remain well intact. The Federal Reserve continues to delay the commencement of lifting their target interest rate above zero until years to come. As a result, real interest rates remain well into negative territory and have no sign of increasing. Money supply growth rates remain positive, with M2 rising nearly 10% in the last 12 months. And U.S. debt and deficits push inexorably out of control with the only hope of resolution being default-mostly likely through inflation.
It is for those reasons that the cyclical pull back in gold should be viewed as a buying opportunity delivered to us as the sole benefit of Europe's debt and currency crisis. Once the crisis in Europe lands on U.S. shores, the true decline in the dollar will no longer have the benefit of being masked behind a more faulty currency. The truth is that both currencies are in decline and while the dollar is falling off the cliff at 90 mph, the Euro is tumbling to towards earth at 110 mph. So it only appears like the dollar is flying if you are looking at the Euro. However, they both are destined to crash into the ground and the only reserve chute to be deployed is made of gold.
Therefore, the dollar price of gold may struggle in the first two quarters of 2012 as Euro weakness sends the dollar higher and commodity prices lower. However, a stubbornly high unemployment rate should bring Bernanke back into the QE game in the second half of this year. The likelihood of yet more dollar creation from the Fed, a continuation of negative real interest rates and a national debt that is most likely to be monetized should send gold to at least $1,800 per ounce by year's end.
President: Pento Portfolio Strategies
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