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Anybody trying to explain what's going on with gold (GLD) right now should first understand what happened in 2011 when gold peaked at above $1900/oz. So what happened in 2011?

The prevailing theme and the major risk to the global economy in 2011 was the potential collapse of the Euro (FXE). Thus, investors searched for safety in a so-called risk-off trade which involved primarily by buying the Swiss Franc versus the Euro, the Japanese Yen (FXY) versus the US Dollar, and gold.

The rising Swiss Franc versus the Euro was creating severe problems for the borrowers in Swiss Franc in Eastern Europe, as well as the problems for Swiss exporters. During the summer of 2011, the Swiss Franc went parabolic and reached parity with the Euro, which set off the alarms globally. The Swiss Central Bank defended the Euro by setting the lower limit to the Euro/Swiss Franc at 1.20 (see Figure 1). Essentially, the Swiss Central Bank promised to buy an unlimited supply of the Euro to keep the Euro falling below 1.20 versus the Franc. In our opinion, that action by the Swiss Central Bank temporarily saved the Euro. Thus, investors began to re-evaluate the need to hedge for the collapse of the Euro, and the resulting risk-off trade. Shortly thereafter in 2011, the Yen peaked versus the US Dollar, and gold peaked at above $1900/oz.

From the second half of 2011 to the second half of 2012, the Euro/Swiss Franc exchange rate stayed at 1.20. Gold was in a range within a striking distance to the new highs and the Yen was near the 2011 highs versus the US Dollar.

The final strike to the risk-off trade was the action by the Japanese to devalue the Yen towards the end of 2012. As a result, the Yen sharply fell versus the US Dollar from 1.30 to below 1.00 (Figure 2), and gold broke-down the support levels on $1500/oz and entered a bear market. Further, the stock market (SPY) (DIA) (QQQ) entered a vicious bull market reminiscent on late 1990s, which is an indication of a shift from the risk-on trade to the risk-off trade.

What are the implications for investors?

  • Investors have been forced out of the risk-off trades in the Swiss Franc and the Japanese Yen by the actions of the respective central banks.
  • Thus, we believe that gold have been a casualty of these currency manipulations - investors exited all risk-off trades, including the gold trade.
  • It is difficult to argue that the situation in the EU has improved beyond the short-term patches - a real progress to the political union needed to save the Euro is still a long-shot.
  • Thus, gold is still a viable hedge as an alternative currency, and should be a part of all portfolios.
  • In fact, gold fundamentals have improved now that the Swiss Central Bank is taking the risk by buying the Euros, and that the Japanese have joined the currency debasement game.
  • Investors have been pushed out of the risk-off trade into the risk-on trade or the stock market, which is, thus, is also a by-product of the currency manipulations and the money creation of the central banks. As a result, we believe that gold will resume the uptrend when the economic and political reality sets-in.

Figure 1. Euro/Swiss Franc futures

(click to enlarge)

Figure 2. Japanese Yen vs US Dollar futures.

(click to enlarge)

Source: Gold: Casualty Of Currency Manipulations?