The gold price is already showing signs of volatility in the New Year with the price rising strongly at the close of 2008 and the first couple of days of 2009 and then falling back fairly sharply.  We seem to be looking at gold as usual as a play on the strength of the US dollar against other currencies and to predict the gold price movement this year and beond will probably be, in reality, largely an exercise in predicting how the dollar will fare.  However, the gold price may also be stimulated by other factors from time to time, which could cause sudden sharp upwards or downwards movements.

Where the dollar is going in the short to medium term is not easy to predict.  Currently it is showing some strength against other currencies, however unjustified this may seem to be for a dispassionate observer.  But the truth is that although the dollar should be weak given all the additional money being pumped into the U.S. economy, which has to be inflationary in the long term, then so are most ‘competitor’ currencies.  With the U.S. Obama stimulus package likely to help bring the U.S domestic economy out of its worst recessionary phase quicker than for most other areas of the world, this dollar strength may continue for the time being until other economies start to pick up on the U.S. economy’s coat tails.

However, once other economies start to stabilise too, and the realisation of the weakness of the U.S. economy’s position with its huge deficit really sinks in, the dollar could be in for a major tumble, which would likely push commodities in general, and gold and oil in particular, to big premiums in U.S. dollar terms, if not necessarily in other currencies.  However, how long this will take to happen is difficult to ascertain.

There are already signs out there that the economic wheels are beginning to turn again – even if very slowly – as it is apparent that some finance is being freed up by the banks – even for some mining projects – albeit at expensive and demanding terms.  But, we are probably not out of the financial mire yet.  The fact that gold did not rise substantially through the economic turmoil of the past year was largely due to the necessity for financial institutions and some large worth individual investors to offload almost anything that was easily negotiable to maintain their short term liquidity, and gold is always easily negotiable.

Now most of this necessity to liquidate assets is out of the market and there has to be the likelihood that the safe haven aspects of gold will generate new price strength on further bouts of financial upheaval – and there is likely to be more of this in the months and years ahead.

What may ultimately give the gold price the major boost that some economists expect will be a wholesale dumping of U.S. assets by investors around the world as they lose patience with the U.S. economy. 

The U.K.’s Daily Telegraph comments on a blog by Professor Willem Buiter, one of the world’s top economists and a former member of the U’K.’s Monetary Policy Committee for the Bank of England.  In his Blog, Buiter says : “There will before long (my best guess is between two and five years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury bills and bonds are still viewed as a safe haven by many. But learning takes place.”

He goes on “The past eight years of imperial overstretch, hubris and domestic and international abuse of power on the part of the Bush administration has left the US materially weakened financially, economically, politically and morally,” he said. “Even the most hard-nosed, Guantanamo Bay-indifferent potential foreign investor in the US must recognise that its financial system has collapsed.”

What the above may suggest is that there is a ‘battle of the safe havens’ taking place in the financial sector.  Much of the world is imbued with the ‘dollar is king’ scenario making it the safest place to invest, and that has come to the fore of late.  What Buiter is saying is that the economic chickens will come home to roost and the world will gradually realise that the U.S. economy in inherently almost terminally weak and this will lead to a flight from the dollar, probably starting gradually and then accelerating.  Gold will be the likely beneficiary as the other traditional safe haven and the faster the dollar falls, the steeper the rise in gold price in dollar terms at least.  In other words gold will ultimately win the battle of the safe havens, but this may yet take a fair amount of time to materialise.