Weekly Gold Market Update

The price of gold bounced off of the $270 level in May, August, and early October. This was viewed as a significant support base that, if breached, might bring on an avalanche of selling that could drive the beleaguered metal to new long-term lows. On October 25 anyone who follows this market let out a sigh of angst and reached for the pepto bismol as gold fell to a close of $266.75. It has since traded sideways to finish the week at $264.60. So, now that bullion has moved south of $270, the question being raised is: "what comes first, $200 or $300?" We emphatically believe the latter, so let's dissect gold's recent moves to gain clues as to when. The day gold declined to $266 was also the day the Euro made an all time low of 82.7 US cents and the U.S. dollar index reached a fourteen-year high at 118.58. Gold has displayed a significant negative correlation with the value of the U.S. dollar, and this correlation has become stronger in the past five years. Thus, it is not surprising that when currencies reach extreme levels, so also does gold.

The Dollar Index has since come off of its October 25 peak, falling to 114.90 on Friday where it closed below its 45 day moving average for the first time in four months. Gold did not rise as expected in reaction to this latest dollar weakness. The likely explanation for this is the upcoming 25-tonne bullion auction by the Bank of England (BOE), which takes place tomorrow, November 7. Traders and bullion dealers have recognized the short-term pattern of declining prices ahead of these auctions and preempt them by selling gold short or refraining from buying. Therefore, once the BOE auction has passed, we will look for some bullion strength on the back of the most recent dollar weakness. Also, we understand that the BOE is examining other ways of conducting their gold sales, the most likely of which is much smaller and more frequent sales that would go unnoticed by the market.

The last time gold fell below $270 was in May 1999 when our familiar friends at the BOE announced that they would begin auctioning their gold. This put gold in a funk that lasted for three months and brought new 20-years lows as gold traded to $252. This oversold condition did not last and, like a bottle of champagne in the Yankees locker room, exploded in September of 1999 with a $70 rally as the European Central Banks announced plans to limit gold sales and lending.

Leaving aside Central Bank shenanigans, there are fundamental trends in the U.S. economy that suggest gold will not remain oversold as we move into 2001. Third quarter U.S. Gross Domestic Product came in at a 2.7% growth rate, which was below expectations and perceived as a sign that the Fed is successfully engineering a soft landing of the overheated U.S. economy. This may give the broader market a year-end boost, however, we point out that there are signs that suggest further slowing is likely, particularly in the manufacturing sector. Demand for commodities, such as metals, wood products, and steel has declined substantially in the second half, and new orders remain weak into 2001. The U.S. NAPM index (National Association of Purchasing Managers) has fallen to levels last seen in December, 1998 during the depths of the Asian economic crisis. High energy prices and wage pressures will continue to squeeze profits, as retailers and manufacturers work off inventories left from overproduction in the first half. Once the ubiquitous inventory overhang has dissipated and if consumer demand remains high, then pricing power returns and inflation becomes more pronounced. If companies continue to have difficulty raising prices or if consumer demand weakens, we expect to see a continuation of the earnings and revenue disappointments experienced in the third quarter from companies as diverse as Home Depot, Intel, AT&T, and Proctor & Gamble. The Fed could clearly become paralyzed between inflationary pressures and a weakening economy. A harder economic downturn is still a distinct possibility, in which case we will look for the dollar to come under pressure and for gold investments to outperform all other asset classes.