Gold Rockets on US Dollar Troubles

By: Christopher_Laird

Gold rose Friday well over $740 setting a new high (not inflation adjusted) since 1980. The USD dropped below a key 78 level on the USDX (currency index heavy Euro weighted). Oil is also rising based on USD weakness. This is not just a speculator driven rally in either gold or oil, as has been the case before the USD started to drop and stay below 80 on the USDX – a big change from the last several years.

This is a new ball game for gold and the USD. Now, we are getting into the gold bullish India wedding and holiday pre buying for jewelry. But compared to that several hundred ton gold take off, anything affecting the USD is a thousand times as important for gold.

Gold's rally is now based on it core attribute – namely as a reserve currency. The USD weakness recently is due to ongoing bad US economic statistics, which are building a negative view on the USD and is going to continue to be adding weight on top of the USD. A bad US economy makes more interest rate cuts likely, and this lowers the interest rate premium of up to 4% the USD has enjoyed for the last few years.

That has held up the USD in spite of the horrible US trade and fiscal deficits.

It appears that a weakening US economy, and consumer, now takes away the attractiveness of the USD, especially as US interest rates fall.

Formerly, our trade partners would defend the USD at 80 on the USDX, as long as our economy could forge on, and people continue to buy on credit. But, as the credit crisis continues to worsen, the prospects of significant credit tightening for the US consumer now takes away that trade plum.

Now, there is less incentive for our trade partners to sometimes unilaterally support the USD when it dropped (like Japan in 2004/5 to the tune of $240 billion worth of intervention).

Some Caution

The USD is now just about 1.42 to the Euro, a level that could cause the EU/ECB to intervene. They have stated recently they don't want the USD to fall below 1.40 and may very well intervene if that happens.

The USD must stay below 78 on the USDX for this $740 gold price to stay with us. It is very possible there will be a significant effort to defend 78 on the USDX. That would cap this present rally for a time if that happens.

Also, Japan has intervened in the past when the Yen/USD dropped to 110, and we are nearing that range as well.

But, we are definitely in a new gold bullish phase based on its reserve currency aspect to a falling USD. This is a big change since the USD used to stay at or above 80 on the USDX, and that pattern has now been definitively broken.

A major question now is will this new gold price level hold, or will it sell off on profit taking. One significant concern here is that the ongoing credit crisis, and problems in the corporate paper markets not rolling over, could lead to another equity sell off. That could leave gold vulnerable to liquidity selling, particularly since funds are now carrying gold profits at these new high prices. Again, the USD must stay below 78 on the USDX for this gold rally to stay with us.

By Christopher Laird
PrudentSquirrel.com

Chris Laird has been an Oracle systems engineer, database administrator, and math teacher. He has a BS in mathematics from UCLA and is a certified Oracle database administrator. He has been an avid follower of financial news since childhood. His father is Jere Laird, former business editor of KNX news AM 1070, Los Angeles (ret). He has grown up immersed in financial news. His Grandmother was Alice Widener, publisher of USA magazine in the 60's to 80's, a newsletter that covered many of the topics you find today at the preeminent gold sites. Chris is the publisher of the Prudent Squirrel newsletter, an economic and gold commentary.

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