Updated from 7:13 a.m. EDT
Contrary to popular intuition, the relationship between the performance of gold and equities is tenuous, at best. So the fact gold has rallied 15% since April 7 amid the stock market's robust rally isn't so strange. Actually, it's readily explainable given the very strong inverse relationship between gold prices and the dollar.
Why stocks have rallied as the dollar has recently tumbled is more complicated, but the relationship between the dollar and gold makes sense "since identical monetary factors and inflationary expectations drive the two," as
Howard Simons once explained.
Near term, the dollar might soon reverse its recent fall. Why? Because it's technically oversold, central bankers in Europe and, especially, Japan don't want to see it fall further, and U.S. economic data might show improvement. Given that, the odds are rising gold will soon suffer a setback. Notably, the yellow metal has retreated from Wednesday's high of $373.50, settling in New York on Thursday at $368.10 per ounce. The overall trend, though, would appear to favor gold.
"Gold is reaching a decisive area at the moment," according to James Moore of TheBullionDesk.com, a Web site dedicated to precious metals. "If gold can breach $375, we could well see a sharp rally toward the year's highs around $390," but failure to do so could trigger "a phase of liquidation" that pushes gold back to the $358-$362 area. (Early Friday, gold was trading above $370 per ounce as the dollar sank anew, especially vs. the euro, which traded above $1.18 for the first time since the day after its introduction on Jan. 4, 1999.)
Less optimistic forecasters see gold retreating into the $330 area, or perhaps retesting the April lows under $320 per ounce. The latter scenario would likely coincide with much better-than-expected economic data, perhaps enough to forestall another rate cut, which would likely strengthen the greenback.
Short-term considerations aside, longer-term fundamentals continue to point toward a weaker dollar and stronger gold prices.
The Dollar's Trend Is Gold's Friend
More prominently, the Bush administration and the
seem to agree a weaker dollar will cure America's economic ills or, at least, stave off deflationary pressures. As an aside, recent action in both the dollar and gold seem to discount the deflation scenario.
Recent comments by Treasury Secretary John Snow and Fed Chairman Alan Greenspan, along with Fed governor Ben Bernanke's
"printing press" speech last November, suggest a concerted effort by U.S. officials to jawbone the dollar lower, and their readiness to take action to that end, if necessary.
Such comments seem to be having their desired effect. The U.S. Dollar Index is down 12% since its recent peak in early December and by 22% since January 2002. More dramatically, the euro is up more than 35% since January 2002 and by 11% since mid-March.
Donald Coxe, chairman and chief strategist at Harris Investment Management in Chicago, observed the Dollar Index has been artificially held aloft by the Bank of Japan's efforts to weaken the yen vs. the dollar. That China's renminbi (yuan) is pegged to the dollar is another restraint to the dollar's fall. "Asians have to keep buying dollars" to offset their trade gaps with the U.S., he said, noting the Chinese bought $97 billion of Treasuries last year and have remained strong buyers in 2003.
Additionally, investors in both China and Japan have been big buyers of gold, helping boost the metal's price. To some bulls, this physical demand for the metal at a time of diminishing mine supply and higher environmental obstacles to new exploration overrides currency considerations in gold's rise.
Meanwhile, the dollar's fall vs. the euro has undermined the appeal of gold to European investors -- or at least diminished their returns from gold, which is priced in dollars.
Conversely, buying gold is an "easy way for Americans to exit from the dollar," Coxe said, suggesting American institutions holding eurodollars -- euros sold here in the local currency -- who've "taken a bath" in those positions are the most likely candidates. Retail investors wary of the stock market and facing diminished yields from money market funds and Treasuries also have sought a haven in gold.
This raises an interesting scenario: Much of the concern about a falling dollar has centered on potential repatriation by foreigners. Perhaps overlooked are American investors shedding their dollar-denominated assets, which, directly or indirectly, is helping boost gold.
Rather than "looking to get rich on a global crisis" or believing all paper assets will turn to "toilet paper," Coxe recommends investors have 6% to 7% of equity portfolios in gold-mining stocks as an insurance policy. In his personal accounts, the strategist owns "big liquid names" such as
( PDG) and
Such holdings represent "prudent diversification and protection against some blowup," he said, noting the U.S. current account deficit is currently more than 5% of GDP. There's "no precedent" of a major industrialized nation having such a high current account deficit "without a massive currency devaluation," he said, suggesting another 25% decline in the dollar is a "reasonable probability." Such an outcome implies gold trading in the $450-to-$500 ounce range, Coxe suggested.
The Golden K.I.S.S.
Perhaps all this discussion of the dollar vs. gold amounts to overanalysis of a simpler story many people fail to grasp, or don't want to acknowledge.
for gold's strength vary from day to day -- in December-January it was the war trade, now it's the dollar -- but the biggest thing going on is a reallocation from paper to tangible assets," said John Hathaway, manager of the
Tocqueville Gold fund. "It doesn't take a lot of money going into gold and out of paper to have a huge price impact because the asset classes are so different in size."
Hathaway agreed "gold needs to correct" in the near term, likely in conjunction with a rebound in the dollar. Such a move could prove beneficial to
, two South African producers who've lagged other gold shares recently because of strength in the South African rand vs. the dollar. (His fund is currently long both.)
That said, "the primary trend is bullish in gold, bearish in stocks and the dollar," he said. "Those trends tend to go for very long times."
Indeed, gold has steadily outperformed the
in the past one-, two- and five-year periods, as well as to date in 2003. Still, skepticism remains high when it comes to the yellow metal, and those who are bullish feel compelled to explain why vs. putting the onus on the metal's many doubters.
From a contrarian perspective, that's a good thing for those long gold and related stocks, which I am, via the Tocqueville Gold fund.
Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
Aaron L. Task.