Reasons For and against Gold Reversing Its Slump

on Jun 6, 2012

A new analysis looks at the prospects of a gold price reversal over the coming year, focusing on gold’s relationship with the world’s most widely held currencies – the euro and the US dollar.

Gold has been experiencing a significant decline, with Bloomberg reporting on June 6 that gold was stuck in its longest slump in a decade. Yet, whether this trend will be reversed is not easy to predict. On 4 June 2012, Seeking Alpha, a website for stock market news and financial analysis, published the analysis of Cliff Wachtel, the Chief Analyst at the binary option trading platform, giving reasons both for and against gold’s next move higher. The analysis looks into gold’s relation to currencies and other asset markets, focusing on the euro and the US dollar as being the most widely held currencies. As noted by Mr Wachtel, a renewed gold uptrend will generally be favoured by policies reducing the purchasing power of both the euro and the US dollar.

Mr Wachtel gives three main reasons for the potential recovery of gold, with the first being the increased money-printing which will be needed to fund the Eurozone bailouts. Mr Wachtel points out that even if the coming Greek elections bring a pro-bailout party, funding the Greek bailouts would require money printing in the absence of another funding mechanism. In addition to the constant Greek “default threat”, if either Spain or Italy needs a bailout, the EU would not have any other choice but to print. Spain alone will require at least €400 bln worth of funding for the coming three years, whereas Italy could become an even bigger problem for the Eurozone bailout funds.

Mr Wachtel then looks at the situation on the other side of the Atlantic, as markets appear convinced that the US government is also likely to do some money printing, a prediction based on the recently released US job reports. On 1 June 2012, the New York Times reported that US employers had added the fewest jobs in a year and that the unemployment rate actually rose. In addition, it was the third consecutive month of disappointing results. As pointed out in the analysis, markets are treating both gold and the US dollar as if the dollar were worth less, and gold worth more, since it is the prime dollar hedge.

According to Mr Wachtel, the third factor in favour of an upcoming gold recovery is that gold is neither a risk, nor a safe haven asset, but a currency hedge. In consequence, its value will either rise or fall depending on fears about the purchasing power of the world’s two most widely held currencies, namely the US dollar and the euro. As already discussed, at present both currencies are at risk of devaluation as a result of continued printing, meaning that the fear of loss of purchasing power will favour higher gold prices. Mr Wachtel however notes that in times of panic the need for liquidity overrides the need to preserve wealth, in which case gold drops despite fears of money printing and purchasing power loss.

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!m[](/uploads/story/65/thumbs/pic_1_inline.png)And yet, there are also three reasons why gold might not be due for a recovery. According to Mr Wachtel, gold tends to move in the opposite direction of the US dollar about 50 percent of the time, meaning that if the US dollar continues to rise on being sought as a safe haven currency, gold prices could suffer. In addition, the deepening Eurozone crisis could potentially spark panic which, as already noted would give priority to liquidity and thus drive gold prices down. The third factor against gold recovery pointed out in the analysis is that gold positions are more expensive to hold in comparison to other assets, meaning that investors may sell to fund losses elsewhere due to more euro-related panic.
In conclusion, remaining bullish on gold for the coming year would depend mostly on the threat of money printing, stimulus and other measures which will dilute the purchasing power of cash and in particular of the euro and the US dollar. In addition, the recovery of gold would also depend on markets’ ability to avoid the level of panic, which could give priority to holding cash.

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