U.S. Dollar Strength and Implications for Gold

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"Gold will, undoubtedly, make new highs this year, but it will likely occur in reference to foreign currencies that are tied to exporting economies. . ."

Human beings have the bad habit of valuing things on a relative basis. The recent USD strength has been a factor of weakness in foreign currencies—NOT strong fundamentals for the USD. This was highlighted Tuesday when both Gold and the USD rallied on the back of Euro weakness. Several fundamentals that are developing include:
  1. The Euro is being tested.

  2. Exporting nations currencies are feeling the pinch.

  3. In comparison to, well, every other central bank in the world, the Fed is far more scrutinized.
The gold market, like all markets, is a discounting mechanism. Currently the gold market is pricing in that the Fed will stop at nothing to try to reflate the equity and real estate markets. Thus, the gold price is holding at levels where it was when real estate, energy and equities were significantly higher.

Gold price maintained value over the past decade by increasing to reflect what appeared to be increasing wealth of the global citizenry. Turns out it wasn't real wealth but rather inflated through irrational exuberance of the prices people paid for real estate and the volume of consumer goods they purchased. Bargaining power has shifted from suppliers to consumers, unemployment is rising and asset prices are tumbling.

Gold remains high on the idea that the Fed will reflate. They have exhausted their first tool (interest rates) and are now focusing on other methods. Fiscal stimulus has its limits; the question remains who will buy all of this government debt—not just the U.S, but every sovereign nation that is issuing record amounts of debt? The Fed could print to buy government debt, which surely will be a major theme this year; but, as much as they want to stabilize asset prices, I believe they are conscious of going too far and of the destructive consequences of high inflation when unemployment is making new highs as well.

The Fed will eventually run out of ammo unless the rest of the world inflates and hands that money over to the U.S treasury to be returned 30 years later. In that scenario, the dollar could strengthen this year.

Gold will, undoubtedly, make new highs this year, but it will likely occur in reference to foreign currencies that are tied to exporting economies—that is the safer bet.

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