Wednesday, December 2, 2009

Is the Gold Rally Getting Frothy?

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

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At the end of Globex trading in New York, spot gold was $1197.00 on Monday, December 1st. Gold then hit another record high during the evening in Hong Kong, with spot reaching $1217.23 an ounce. New highs were also reached in British pounds - 733.02, euros - 805.71, and in Swiss Francs - 1214.44. While U.S. investors are getting more bang for their buck, the gold rally is global and an indication of a broad-based lack of confidence in fiat currencies. This is a long-term trend and will be lasting well into the next decade, if not beyond. That doesn't mean gold will be going straight up however, there will be sharp reversals and investors need to watch out for them.

A major impetus for the current rally was Barrick Gold eliminating its fixed-price hedge book. Barrick wasn't making money on the continual rise in gold prices because of its hedging activities. Shareholders forced management to close them out. Barrick had to buy back the hedge contracts and this was originally expected to take somewhat into 2010 before this was finished. Apparently, Barrick closed out all the hedges by the end of November. This will cost Barrick $6.0 billion in charges against earnings. Gold has been rallying since 2001 and one wonders why it took Barrick management 8 years to react to this. Investors who think management and industry 'experts' always know their market best, might want to reconsider this notion. These are the people who frequently are the last to catch on to what is going on.

The end of an event that has been propelling a market should be paid attention to by investors. It can mark a temporary pause in an uptrend. Gold is already overbought on the daily and weekly charts, so it is vulnerable to some selling. The momentum however is extremely powerful and the current overbought state can last for awhile longer before selling comes in. The selling will only be temporary however. The peak of this rally is still at least a few months off.

Barrick gold closing out its hedges is only one of many factors pushing up the gold market. The declining U.S. dollar is a far more important. The trade-weighted dollar has been as low as 74.23 and has a band of support in the 72 to 74 level. A test of the March 2008 lows (the same month when gold first broke $1000 an ounce) below that band is almost certain. The euro testing the 1.60 level should be taking place around the same time. Lower lows for the dollar and a higher high for the euro should not be ruled out next spring. The longer term trends are pointing in that direction - and those are the trends that should be watched most closely.

Disclosure: Long gold.

NEXT: Our Current Economic Illusions

Daryl Montgomery
Organizer,New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.


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