The price of gold has recently gone berserk, but that's no cause for alarm.
By PINCHAS LANDAU
The price of gold has recently gone berserk, but that's no cause for alarm. True, the yellow metal has been on an uptrend for five years, after a long decline from record highs of around $850 an ounce in early 1980 ended at a price barely above $250. True also that over the past year or more it has begun to attract growing interest from investors of all stripes. Still, the run-up and sell-off of the last few weeks is unlikely to be the end of the bull market.
For most of the past few years, gold has been closely (and inversely) tied to the US dollar. When the dollar fell, gold rose, and vice versa. That's why gold did well in 2003-2004, when the dollar declined sharply against most other currencies, notably the euro. In that period, the price of gold denominated in euro hardly moved. But during 2005, the link between gold and the dollar frayed and then snapped. Although in the first half of the year the old relationship held, so that the dollar's strength against other currencies translated into a falling price for gold, the extent of this fall was much less than that of the euro, sterling and other currencies, notably the Japanese yen, against the dollar. Consequently, gold's price began rising noticeably in euro, sterling and yen terms. As time went on, this change became more pronounced and the price of gold "uncoupled" almost entirely from those of the currencies. The dollar rose, but so did gold in dollar terms, so that the price of gold in euro and yen terms was now driven by two factors, namely the underlying price of gold and the currency impact of the dollar's strength.
THE REAL action began in November, when the price of gold underwent a correction after reaching its highest point since 1987 - around $480. The sell-off stopped at around $455 and the price stabilized briefly. Then it started rising with increasing speed. This time the supposed "barrier" around $480 was swept aside and the price rushed on toward $500. Expectations that heavy selling at or around the $500/ounce level would stop the uptrend proved incorrect, as the price rose above that benchmark and stayed there. That brings us to last week, when the price edged up to $510.
At that point, normal trading gave way to a stampede: the price began shooting up by $5 a day, then $7, then $10 and, on Monday by some $15 in Far Eastern trading, to a high in excess of $540. With each passing day, the "gold bugs" wrung their hands, complaining that the market had become irrational and that in this environment a sharp correction was inevitable, although it was impossible to know when it would occur, let alone how much the price might rise by then.
One thing, however, was clear: the focus of the action was Japan. Although buying interest had become global, it was a mania among Japanese investors, mostly private individuals fed up with zero interest rates and a falling yen to boot, rather than investment institutions.
The inevitable duly occurred this week, with the pace of decline exceeding that of the rise of the previous week, as usually happens in these circumstances. Between Monday and Thursday, the price dropped from over $540 to just above $500, but no-one is prepared to guess whether the fall will continue. With markets winding down for the holiday season, liquidity will dry up and sharp moves are more, rather than less, likely.
Nevertheless, there is a broad consensus that after the current volatility abates, the underlying trend will reassert itself. In other words, the price will resume its rise some time in 2006, but opinions vary as to whether this will occur immediately or only after a more prolonged stabilization.
The reasoning behind this consensus is frighteningly clear: investors have less and less confidence in the US dollar because of the twin deficits towering over the American economy, but they have little faith in the sclerotic euro or the grossly manipulated yen either.
So the beneficiaries of the flood of money into the Middle East, Russia and China discussed in last week's column are looking for a more secure asset than paper money. That's why we are likely to see gold prices well into four figures before this bull market is over.
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