MichaelCD - The Blog.

The thoughts of Michael Cadwallader. Coffee loving, history book reading, Cheshire man.

Friday, September 22, 2006

Gold Prices

I doubt anyone took my advice and bought some gold, simply because of what they read on this blog. Nevertheless, with gold struggling just below $580 an ounce, if anybody did take my advice I would imagine they would want to use my face as a dartboard, at this moment in time! But I am not worried in the slightest. Unless the US is facing deflation, with commodities, housing and the economy turning south, then the fundamentals remain the same.

However, if people are getting a bit jittery about gold, then this article should dampen the anxiety a bit:
As expected, more talk of a slowing US economy caused base metals prices to continue their decline last week and, as expected, falling base metals prices dragged the gold price down as well. Very few institutional investors differentiate between gold and other metals; they bought them all as a hedge against a weaker US dollar, so when they finally wrapped their heads around the fact that the US economy can slow down and that a slowing economy will cause a decline in base metals demand, they started selling their metals - including gold.
Why do I believe it is only a temporary downturn? Well.....

US money supply (as measured by my own estimate of M3) increased by 8.4% over the past twelve months. Current gold inflation, which is mine supply as a percentage of all above-ground gold (all the gold that has been mined to date), is around 1.6% per annum. That is why the gold price continues to rise against the US dollar over time – it is as simple as that. In the short term, however, exchange rates and investor sentiment also have to be brought into account and it is mostly they that cause short-term volatility. But in the long-term, the gold price in any currency will rise by an amount equal to the difference between its inflation rate and the inflation rate of the currency you price it with.

My model of the gold price (based on the inflation rates of gold and the US dollar) puts the gold price at around $900 an ounce with the difference between the current gold price and $900 being accounted for by an over-priced US dollar. For gold to rise from $600 an ounce to $900 an ounce requires the dollar to fall, on average, by 35%. The Organization for Economic Co-operation and Development (OECD) said earlier this year that the dollar had to fall by 35% to 50% in order to balance the US current account gap. I don't know how they came up with those figures, but they correspond very well to my own expectation of how much the dollar should decline.

If the gold price is going to rise to $900 an ounce then gold at under $600 an ounce is starting to look attractive again, but there is still downside risk in base metals and until the gold price uncouples from base metals prices I would not get too aggressive on the buy side. But gold will decouple, because unlike base metals, its value (and long-term price) is not dependent on economic growth.


At 7:47 am, Blogger ** Ego ** said...

Central bank selling accelerated in september: http://allafrica.com/stories/200609210820.html


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