Gold in for volatile time in runup to G20

Not enough bang for the buck - pressure on U.S. administration to support dollar could create volatility in gold markets.

LONDON - 

There is increasing global pressure on the U.S. Administration to do more than just pay lip service to a strong dollar policy.  So far the ‘strong dollar policy' has actually been one of benign neglect with the U.S. letting the world's global currency drift downwards to the extent that much of the rest of the world is beginning to cry foul as exports are becoming uncompetitive against U.S. products, while in the U.S.A. itself the laissez-faire policy remains in place as long as the Fed sees inflation remains under control.

The worries about dollar weakness are already leading to some countries making moves to devalue their own currencies in the markets, and it seems likely that matters will be brought to a head at the G20 meeting due early next month in Scotland, with world leaders likely to gang up on President Obama to bring to an end the ‘strong dollar' policy which in reality has actually been a ‘weak dollar' policy.   But, the U.S. seems more than happy to let the dollar drift downwards as a contributor to ending its own recession through creating a domestic business climate which will start putting people back into work as manufacturing drifts back from the developing world.

Indeed it is difficult to see how the U.S. can do otherwise given the continuing release of fiat money into the economy to try and generate some stimulus and the effective negative interest rate policy currently in place.  The Administration fears that stopping the flow and increasing interest rates at a time there is still little sign of inflation will plunge the economy into an even deeper recession.

One suspects that the likely pressure on the U.S. may lead, at least temporarily, to the Administration paying a little more than lip service to its ‘strong dollar' which is likely to lead to a reversal in the dollar's drift downwards.  But as long as the programme of Quantitative Easing continues, the subsequent dollar recovery is likely to be shortlived.  The markets will see to that.

But what does this mean for gold?  With the gold price naturally moving counter to the value of the dollar there is likely to be downwards pressure, at least in theory, on the gold price.  Indeed we are already seeing this beginning to occur as the dollar appears stronger as other countries move to push down their own currencies.  But at the moment there seems to be good buying coming in every time the gold price dips.  If gold can hold its value through this likely period of pressure and volatility up to the G20 and beyond, then this has to be extremely positive for the yellow metal and means that it will again have managed to decouple from the dollar - this has happened before.

Gold is a special case though and other commodities priced in dollars may not fare so well.  A stronger dollar in the short term will put pressure on metals prices while unless a subsequently weakening one proves to be enough to sufficiently stimulate the U.S. domestic  economy to the extent that U.S. commodities demand picks up sharply, weakness could continue as realisation sets in that the western economies are not truly recovering after all.  And on the other hand there is the potential impact on China even if U.S industrial usage does begin to pick up.  Exports, to the U.S. in particular, are still a key part of the Chinese economy and if these continue to fall further as a result of manufacture relocating back to the U.S. then Chinese demand, which has been supporting the metals commodities markets to such a great extent over the past year, could drift away with a potentially very adverse effect on global metals commodity prices.

Despite the likely pressure on the U.S. Administration, the consensus among U.S. economists and analysts suggest that after perhaps a short period of relative strength over the next month, the dollar will resume its downwards fall.  The still huge amounts of fiat money being pumped into the U.S. economy, and the country's huge deficit, would seem to make this inevitable.  For gold this suggests a return to a strong upwards momentum developing again at least by the start of 2010.  However if it survives the likely downwards pressures over the next few weeks without any serious fall-off, this will be a very bullish signal indeed, and the price could even start to move sharply upwards before the year-end.

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