Schmidt Management Company
May 11, 2009
Will the wealth destroying policies of the Obama Regime make the People’s Bank of China full-fledged Gold Bugs? Chinese officials announce their purchases of Gold, and continue to raise concerns about U.S. economic policy and the associated implications for the value of the U.S. dollar. One might think they have indeed become Gold Bugs. If that be the case, no real surprise should be registered. A casual observation of government economic policies around the world, and in particular in the U.S., since the invention of the central banking and fiat money would convert any rational individual into a Gold Bug. Given the wealth destroying policies of the Obama Regime, a large number of people might wake up to be Gold Bugs.
In the above chart is plotted a dollar index built on the median movement of the dollar versus a basket of major currencies. In today’s world, capital flows dominate all other considerations in determining the relative values of currencies. The widely used trade-weighted index is a fairly obsolete concept, built on early 20th century concepts of trade, but remains commonly used. The median is used as a measure of central tendency to avoid the distortions that often develop when using common averages.
In that chart is an ominous picture. The U.S. dollar is breaking what little support might have existed. The U.S. dollar is about to go into free fall. Just as traders were quick to ride the dollar higher, on false pretenses, traders will be as quick to sell the dollar. Already, some currencies have rallied strongly against the dollar. No one observing a chart of the U.S. dollar is going to be willing to grab this “the falling knife.”
Part of the impetus for the dollar’s rally of the past year was the repatriation of funds made necessary by the joyful collapse of the hedge fund sector. Fundamentals, of any kind, did not exist to support the dollar’s rally. What is now happening is the correction of non-equilibrium values in the foreign exchange market. And just as the dollar overshot on the upside, it will overshoot on the downside.
We can now reasonably expect that the dollar will make a new low, as measured by the index in that chart. That development would have some strongly positive implications for the price of US$Gold. A new low in that dollar index translates into a U.S. dollar price of Gold of more than US$1,100. Gold Bugs may indeed have a joyous holiday season this year, brought to you by the Obama Regime’s destruction of the dollar.
A natural question that then follows is when that price might be achieved. In large part the speed of the assent will be dictated by the level of institutional participation in the Gold market. Based on the experience of the past year we can make some time estimates, though frail they are. If the institutions are active in the market as the dollar crumbles, US$Gold could achieve that level in a September - December framework. Without that participation, December - March would be more likely.
That $Gold is under valued in an intermediate time frame is only part of the equation. Two remaining questions must be answered.
If I do not live in U.S. dollars, should I buy Gold?
Finally, should we be buying Gold today, at these prices?
Flip side of the price of Gold in your currency is the Gold price of your currency. Gold price of your currency is how many ounces of Gold are necessary to buy one unit of that currency. The calculation is simply 1 divided by the price of Gold in your currency. If the price of Gold declines when denominated in your currency, which happens when your currency strengthens, the Gold price of your currency is rising.
To simply things, let us consider the chart above. What has been done is to plot the rank of the major currencies by the strength of the Gold price of that currency. In other words, the Gold price of the South African rand has been the strongest of the twelve currencies listed. The South African rand has been too strong relative to Gold. The currency is likely over valued relative to Gold. Or from the other direction, the Gold price of the currency is probably too high. The higher your currency ranks in this chart, the more under valued Gold is likely to be in terms of your currency.
Thus far, we have set an intermediate term target for $Gold of US$1,100. Second, we have identified in which currencies Gold is probably the most under valued. Final question deals with whether or not we should be buying today.
To help answer the final question, let us consider the chart above. $Gold has broken the down trend line which had served as resistance. However, it is now short-term over bought. That condition comes from the rapid decent of the U.S. dollar in recent weeks. Additionally, institutional recognition of the role of Gold in portfolios has become more widespread this year.
Given that $Gold is probably short-term over bought and some possibility of Summer doldrums developing, investors should probably simply use weakness to do their buying. $Gold prices below US$900 should encourage all buyers. Price weakness in the AM on New York City time should be used in particular. Those investors living in currencies at the top of the second chart should be aggressive buyers during such periods.
Summer of 2009 may be the last great buying opportunity for Gold. What we mean is that the prices that develop in the next few months, or weeks, may not be revisited. In the next leg of the structural Gold bull market, US$1,000 is more likely to be a floor than a ceiling. Waiting to buy Gold till the next announcement of purchases by the People’s Bank of China may be too late. China’s most recent comments on the dangerous economic policies of the Obama Regime remind this author of an old joke. When the wife complained to the farmer for shooting the mule, he turned to her and said, “That’s once.”
© 2009 Ned W. Schmidt
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