Wednesday, December 11, 2013

Gold, the US Dollar, and the Seesaw of Pain

For a long time, the relationships between gold and the US dollar have been out of whack. Usually they're on what I call the "seesaw of pain" -- when one goes up, the other goes. down. But for months, they've moved in the same direction, as you'll see on this chart.
 (Updated chart)

As you can also see on the far right side of this chart, in the past week, we've seen gold head higher while the US dollar goes lower. That's the first time this has happened since mid-October, which was itself a change from the previous trend. Is the relationship between gold and the dollar back to normal? And if so, why?

Here's another question: Why is the US dollar slumping?  The economy is improving. The November jobs report was solid. 3rd quarter GDP was revised up to +3.6%, in line with the recent stronger ISM manufacturing readings. Motor vehicle sales for November also made a post-recession high. Gasoline usage is up year over year and is expected to keep increasing, another sign of economic health. And Congress has worked out a budget deal that should prevent another painful battle in Washington. In short, while America's road to recovery may be painfully slow, we seem to be picking up speed. And at least we're going faster than Europe.

But maybe it's a relative expectations game. And I'm talking expectations about the euro and to a lesser extent, the British pound.

On Monday and Tuesday, there was a European Finance Ministers meeting. The european finance ministers made real progress on a banking union framework. Why is that important? Because it would once and for all remove the potential for individual banks (like those in Greece, Spain, Ireland, Italy, etc.) to bankrupt an entire EU country.

A banking union will create a central European regulator to close troubled banks and create a centralized European fund to recapitalize banks and make depositors whole again.

The main sticking point was the Germans, because they know they'll be writing the checks. But they seem to be over it now.

And this is a real fundamental positive for Europe. If you can take a potential future financial crisis off the table, Europe looks a lot more attractive.

The other development was that Bank of England head Marc Carney made a speech in New York. He acknowledged that the UK economy is recovering.  He also said that the UK will need low rates into the future. But anyone with eyes can see that Britain's housing prices are skyrocketing. Add in an improving economy, and it's likely that the UK will raise its benchmark interest rate sooner rather than later.

So, if the outlook for both the euro and the pound sterling is improving, then relatively speaking, the US dollar loses some of its safe haven status.  And that, I believe, is why the US dollar is going lower ... and also part of why gold is suddenly looking better.

The other part of gold's recent perkiness is Chinese demand for gold, which is enormous and growing. But I'll write more on that another time, as well as selling of gold by exchange-traded products. That may be winding down.

Stay tuned.

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