Commodities | Jul 17 2007
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By Greg Peel
It was a quiet night in the precious metal markets last night as traders settled down to await this week’s important economic data. Wednesday night will bring the US consumer price index measure for June – a number which will be more closely scrutinised than most given the currently perilous state of the US dollar. As the following chart illustrates (courtesy of The Gartman Letter) the US dollar index of major currencies is sitting uncomfortably on a long term support line.
As Dennis Gartman explains, what can’t be seen on this scale is that the level of 80 for the index also served as a bottom in 1995, 1992, 1988 and during 1979-81. A triangle pattern as such usually indicates the break will be in the direction of the trend when entering the triangle.
The US dollar has fallen rapidly from 1.33 to 1.38 against the euro, and although it could be forgiven for wanting to consolidate around the 1.38 level there are few analysts not tipping a further breakdown. What can potentially save the dollar however, is inflation. If the core CPI number surprises on the upside then expectations will again be for the next move in the cash rate to be up, thus providing support for the dollar. The Fed has kept rates on hold for several months now while the rest of the world, and particularly Europe, has been adjusting rates higher. However, not everyone expects the next move to be up.
Fed chairman Ben Bernanke has maintained a rhetorical stance that inflation needs to be watched closely. As the US economy has appeared to be on the improve, the chances of another rate rise have also improved. But then there are those convinced that the next move will have to be down. For one thing, an increase in rates threatens to exacerbate the already incendiary mortgage market.
Not only will the CPI be released, but on Wednesday and Thursday Fed chairman Ben Bernanke provides his customary six-month testimony to both houses of Congress. There will thus be no excuses for not knowing just what the Fed chief is thinking. His speeches will be run over with a magnifying glass, and every word analysed as meticulously as a Shakespeare play might be. The subtlest clues could be the most influential.
The headline CPI is forecast for a rise of 0.2%, down from 0.7% in May. A number of this magnitude is sufficiently benign to be a relief to the stock market if it comes in as expected. If it is higher, then the stock market will fear a rate rise. If it is lower, then the US dollar will probably breakdown. This puts gold traders in a difficult position.
Any rise in interest rates is bad for gold at either end of the curve. A high CPI would probably set US bond rates heading north again, undermining the value of gold. But gold is the inflation hedge. The problem is that gold has been acting more as a simple inverse trade to the US dollar of late rather than a global inflation hedge. As the latter, it should rise in all currencies. The chart of the Australian dollar listed gold ETF shows gold has not proven much of an investment downunder of late.
Nor has gold risen against the euro. Rather, the US dollar gold price has avoided falling further toward US$600/oz because the US dollar has been falling against most currencies (except the yen). However, as the chart below suggests, the gold price may yet be set to decouple and move of its own volition. If the world is fearing inflation, the gold price should be higher. Gold in euros has retraced above the moving average.
The lines on the graph are drawn by Dennis Gartman, who has once again become bullish of gold. (Close observers will note this same chart was used last week to suggest gold was threatening to break down in euros, so it appears a crisis has been averted).
The question of inflation takes on a different meaning if one ignores the CPI (as many an economist is wont to do) and looks at the money supply. Last year the US Federal Reserve stopped publishing money supply numbers, explaining that they cost a lot of time and effort to evaluate and were not very useful anyway. That was their story. Cynics will tell you that the Fed stopped publishing M3 because it didn’t want anyone to know just how many new US dollars it was putting into the system every day in order to pay its debts and cover its positions in gold sales.
In whichever camp you fall, the following chart at least suggests one measure of inflation is indeed on the up. This is exactly what the gold uber-bulls have been talking about for a while – the US dollar is hopelessly inflated and must collapse.
It’s going to be a tough one for gold traders to judge, however, with so many conflicting variables in the inflation rate, the bond rate, the oil price and the US dollar. The only thing that is for sure is that if the US dollar falls through index 80, gold will rally strongly in US dollars. As to whether it can truly rally – against all currencies – is a wait and see.
