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When demand for the dollar outstrips the supply, the value of dollars goes up. But the supply of dollars has been rising steadily at an average of 10 per cent annually from less than $1 trillion in 1980 to over $12 trillion today -- and the fundamentals for gold today have much to do with the resulting drop in demand for dollars.
When dollar-denominated assets lose value, people ditch dollars. As we have documented since the credit crunch began in August, the subprime mess has been the dollar's worst disaster in the last three decades. The subprime meltdown is now causing supposedly high-quality government sponsored debts to be selling at 70 cents on the dollar (Mad Cow contagion as we call it).
With the subprime mess as an extensively featured headline, and global central banks coming together to combat mortgage liquidity crises by printing their own currencies to support US mortgage debts prices (interestingly lead by the ECB, not the Fed!), the dollar crisis relative to other fiat currencies may have reached a climax. This means the fall of dollar index may be suspended, at least temporarily.
In November 2007, the Canadian dollar at one point traded at a 10 per cent premium to the dollar, highlighting that other fiat currencies have been the main beneficiary from the current flight from the dollar. However we'd like to point out the ECB-led charge in printing Euros, the slowing Canadian economy, the housing/mortgage problem in the UK, and a widening trade deficit in Australia are cases where the outlook for other countries' respective currencies are mixed at best.
With gold prices already more than having tripled from their low of $250 per ounce, the fundamental driver for gold in 2008 will likely come from the flight from other fiat currencies besides the dollar. This means that gold and the US dollar index may very well rise in tandem. Technically, the dollar index is rebounding and gold has just broken out from the euro, Canadian, and Australian dollars.
Gold: Comparative value with commodities
Gold has lagged behind oil and base metals such as copper since the commodities bull started in 2001. Theories for gold's shortcomings are many, ranging from gold's antiquated status to the famous manipulation theory.
Gold's antiquated role is rubbish. While we believe, manipulation exists, as with just about every market, its impact is very limited and dramatically hyped up.
We can only speculate on gold's somewhat lackluster performance to date, mainly China keeping prices at bay. Without China, most consumer goods from computers to blankets to shoes would be selling at least at 30 per cent higher prices. However with revaluation of the Renminbi now well underway -- and already $1.2 trillion being held by China -- we will now see Chinese goods steadily rise in prices in Dollar terms.
Gold versus global investments
There are lots more investment opportunities from real estate in Thailand to IPO's in Bulgaria to soak up excess dollars. However, with most emerging equity and real estate markets already doubling and tripling, the easy money has been made.
Current investment psychology says that, after two decades of being taught inflation is dead, the new generation of money managers are only now grasping that inflation is alive and well. It was only five years ago that the public was fretting about Japanese-style deflation. The Federal Reserve talked of deflation while oil zoomed from $20 to nearly $100. However, now can see that $100 oil means inflation.
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