The dollar price of gold not a good indicator of where it really stands
The U.S. investor in particular generally looks at the gold price in U.S. dollars, but in reality should be looking at the price in Euros as the recent apparent price appreciation has been mostly due to dollar decline.
Posted: Wednesday , 27 Apr 2011
We are writing today from the euro gold price point of view to illustrate what's really happening to the gold price. The gold price continued to pull back as the euro price of gold stood at €1,030.41 ahead of the gold Fix. It has pulled back from €1,041 over the last couple of days and still is far away from its peak at €1,065.
However, across the Atlantic in the U.S., the dollar continues to fall against the euro and, ahead of the first London Fix, the dollar stood at $1.4631 against the Euro and continues to look anemic. Consequently, gold is higher in US dollars at $1,507.65 but lower in the euro, before the first London Fix.
The London Fix continues to dominate the gold price in both currencies and accurately reflects London and Asian demand. The London afternoon Fix continues to reflect both European and U.S. demand for physical gold and the main global open market supply of gold.
Prices outside the Fixes reflect the local conditions of each market where they are quoted. Physical supplies for those markets usually come either direct from individual suppliers or from London.
How can U.S. investors see the gold price clearly in global terms?
THE FALLING DOLLAR
We find that U.S. investors struggle with a global view of gold and silver markets. In the U.S. gold is seen as having a predominantly dollar price, whereas the euro price of gold more accurately describes demand and supply at this time. As a result, U.S. investors are excited by record U.S. dollar prices and fear they may fall back.
But U.S. dollar record prices are not due to record gold demand but to the falling dollar.
A record gold price in the euro was seen a while back at €1,065. Should the U.S. dollar fall to $1.50 against the euro we must see the dollar price of gold stand at $1,597.50 if gold were to merely equal record euro prices. If the dollar continues to fall, the gold price will move up through $1,600 and more, without moving up in the euro!
Until U.S. investors adjust to these realities, we expect only the more globally focused U.S. investors to value gold as a protection against a falling dollar. The global viewpoint will look at the dollar as just another currency, albeit the world's main one. With its structural problems, it has virtually ceased to measure value. It is now both the tool, as well as the consequence, of the U.S. monetary authorities.
As a tool there is no doubt that the U.S. stands to gain considerably in international trade if the dollar continues to fall. With the falling dollar, the price of U.S. goods in foreign currencies falls too. The Trade Balance of the U.S. has been a fact of life for more than a decade and is unlikely to return to a surplus, simply because U.S. manufacturing has been outsourced to places like China and other parts of Asia, by U.S. companies seeking lower labor costs and greater profits.
This remains a structurally unchangeable fact until U.S. wages, measured in foreign currencies such as the Yuan, are cheaper than foreign wage levels. No doubt then U.S. manufacturers will then want to relocate back home. By then, Asian manufacturing companies will be so entrenched that U.S. companies will find it difficult to compete with the people they taught. The dollar has to tumble considerably more for this to be even remotely attractive to U.S. manufacturers.
· As a consequence of loose monetary policy out of consideration for the U.S. economy, a near complete disregard for the dollar's role internationally, the dollar has and will cheapen much more. That will be the case if other nations' monetary authorities permit it to [without trying to undermine their own exchange rates]. If they don't, currencies will cheapen together making precious metals still stronger.
By implication, a global ‘reserve currency' has to serve as a currency that is capable of defining the value of products and remaining stable enough for prices to provide sufficient profits for businesses to continue. An unstable declining currency clearly fails to do that. It will eat profits up [Often between 5 and 30% of price]. For instance, a price set when the dollar was at $1.25 to the euro may incorporate such margins. If it falls to $1.50 against a dollar-priced product, the entire margin disappears. Meanwhile, where an exporter prices in the dollar [which is usually the case] and buys forward exchange rate cover to protect his margins, his contract costs will rise to reflect the instability of the dollar and his costs creep higher and higher over time. This makes manufacturing an exchange rate gamble or extra cost to his business that raises prices. But he does have the option of not using the U.S. dollar in international trade. But this lowers the use of the dollar in international trade, eventually lowering the exchange rate of the dollar even more.
We believe that the current myopic view of the gold price in the U.S. dollar will continue for a while still, until there is a shock that will force a more global perspective. It may happen slowly or suddenly. The earlier investors arrive at this viewpoint, the greater the profits they will make out of the precious metals and the more effectively they will protect their existing wealth against a falling dollar.
Julian Phillips is a long time specialist analyst of the gold and silver markets and is the principal contributor to the Gold Forecaster - www.goldforecaster.com - and Silver Forecaster- www.silverforecaster.com - websites and newsletters