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A Weak Week for Gold
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(September 9, 2006) In 48 hours time, gold lost 5% of its value this past Thursday and Friday. What causes such seismic valuation shifts in a metal whose market is perhaps the oldest in existence, a market that essentially defines the value of money itself?
This week’s market moves brought out the gold commentators in force. Although divining markets is tough work, there is always a quotable crowd willing to read the tea leaves and offer some words of enlightenment.

Myra P. Saefong of Marketwatch in a September 8 article mined a few nuggets for us concerning this week’s market action. These various market analyses all have a very solid ring to them, but of course it will take time to assay their true worth:

“Gold's sharp sell-off can be attributed to a failure once again to the rise above key resistance at $640, a short covering rally in the U.S. dollar, and potential European central bank gold sales as yearly sales quota ends September 26th," Ms Saefong quotes Peter Grandich, editor of the Grandich Letter.

She also found this from unnamed analysts at South Africa’s Standard Bank: "Gold's inability to consolidate above $632 coupled with further expected strength in the dollar doesn't bode well for the yellow metal today..." "For the bulls in the market support at $607 is crucial now and a break of this level will certainly initiate technical selling from the funds."

Ms Saefong found more analysts willing to talk, about talk. A research firm called Action Economics said “gold was also under pressure from talk that at least one European central bank has been selling the metal.” But on the other hand, she also quoted the firm’s analyst as saying, "Good demand is likely under $610 in gold, where physical buyers showed their hand in some size last week."

In the same article was this simple proscriptive: "Investors should use this fund-driven selling to buy," said Ned Schmidt, editor of the Value View Gold Report.

But perhaps not right away, according to Kitco’s John Nadler:

“…The growing apprehension among some gold bugs now, is that we may first see $570 or worse ($540) in lieu of $640, in a repeat of the May price slump. Although some shorter-term moves can, and have been built on geopolitical problems and on the gyrations in crude oil, ... at the end of the day the bullion market needs the foundation of offtake that it depends on in the largest proportion," he said.

Note the phrase “the foundation of offtake that it depends on in the largest proportion.” Although it has been some time since we sat though Economics 101, it occurs to us that perhaps the word that Mr. Nadler is looking for here is “demand.”

But who is to say that this week’s lack of demand doesn’t have a simple explanation? Here's an idea brought to our attention by a September 9th article entitled Gold Remains Weak on Overseas Trend, Lower Demand from the website NewKerala.com from New Delhi, India:

"The market was in weak mode following a fortnight of 'Sharads', an unauspicious fortnight in Hindu mythology for buying anything new."

Mythology aside, more likely that the price of gold is, as always, a supply and demand equation. Gold prices on Friday’s spot close were around $609, down 2% for the week, and down some 15% from gold’s May 2006 highs.

The $609 figure is also up – up some 15% from the first trade of January 2006, and up some 40% since the summer of 2005. It has also more than doubled in price during this decade. For instance, on the day of the World Trade Center destruction, 9/11/01, gold prices spiked from $271 to $287 per ounce, and didn’t trade above $300 until 2002. The gold market has come a long way since then, for a variety of reasons.

But with gold prices currently in the doldrums, the question of where gold is headed naturally arises. The negative case for gold prices boils down to this: the current housing slump becomes deep and prolonged, possibly leading the US into a recession which will take pricing pressure off lumber, copper, and the whole commodity complex. If so, inflation could possibly be nipped in the bud by lessened economic activity, and gold prices would suffer.

But another possibility is that the rest of the world does not follow the US into recession. Commodities such as oil and base metal prices have risen recently not just on US demand, and could continue to do so. Should the world economy continue to grow while the US economy slows, we could see a period of stagnancy during which the dollar continues to lose buying power even as the US economy slows. In the 1970s, this was called stagflation.

In other words, pick your poison.

Of course, the short term answer is, as always, who knows? Long term, the outlook is more certain. Being cognizant of monetary history, we are in complete agreement with Bill Bonner of DailyReckoning.com:

“We like gold because, while we cannot predict the future, eventually and always, paper currencies disappear and gold remains."

 

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