Gold Glitters as We Usher in 2008

Includes: FXI, GDX, GLD, UDN
by: Prieur du Plessis

Waving the old year goodbye with a few new records under the belt is no mean feat, but the real glitter for gold bullion is that most indicators seem to point to more good news down the line.

The first record is that the gold price recorded its first ever month-end close above $800 on Monday, December 31. As mentioned in my blog post “Gold bullion - a belated Christmas gift” (December 27, 2007), gold had only closed above this level on two days during its 1980 surge, namely: $830 on January 18 and $850 on January 21. However, the end of January 1980 saw the price significantly lower at $659.

Looking at monthly averages, in January 1980 it was $675. This figure was equaled in May 2006, and was exceeded for the first time in April 2007. A new record of $806 was established in November 2007, whereas December’s average was slightly lower at $802.

It is, of course, true that in inflation-adjusted terms the gold price is still a long way off its euphoric days of 1980. If adjusted for movements in the U.S. consumer price index, the $850 record would today be around $2,250, and the average for January 1980 around $1,790.

Real gold price* (January 1971 to October 2007)

*Monthly averages revalued to Q3 2007 prices. (Gold price deflated by seasonally adjusted U.S. consumer price index.)

Source: World Gold Council

More importantly, the gold price is not only making headway in U.S. dollar terms, but in most major (and minor) currencies, as well. This is a manifestation of increased investment demand, whereas the initial rise in the gold price from its low in 2001 ($250) until the middle of 2005 was mostly a reflection of U.S. dollar weakness. The World Gold Council reports that identifiable investment demand during the third quarter of 2007 was nearly double year-earlier levels in tonnage terms.

Further to the table published in my previous article, gold has now entered record territory in terms of most currencies other than the U.S. dollar. This includes the currencies of the two largest consumers of gold, namely the Indian rupee and the Chinese renminbi as illustrated below. (According to the World Gold Council, China has just overtaken the U.S. as the second largest gold consumer after India.)

Gold in Indian rupee


Gold in Chinese renminbi


Other central banks pursuing a policy of increasing their gold reserves relative to fiat currencies include Russia and Saudi Arabia. The following charts show the gold price in their respective currencies:

Gold in Russian ruble


Gold in Saudi riyal


I have debated the fundamental case for investing in gold on a number of previous occasions, but let’s recap the implications of the inflation/deflation scenario by means of an excerpt from Richard Russell’s Dow Theory Letters. (I should add that he has been reading the gold cycle with painstaking accuracy.)

According to Russell:

… the Fed is fighting the potential forces of deflation. What deflation? Deflating home prices, a potential decline in consumer spending, plus the specter of rising unemployment. … let’s say that in 2008 the economy turns ‘bad’. In that case, the Fed will step on the accelerator and fight the downturn with everything at its command, which … means expanding liquidity and declining short rates. … the ideal atmosphere for a rising price of gold.

Examining the opposite side of the coin, he argues:

Let’s say that the U.S. economy stabilizes. The housing situation hits bottom and begins to improve. Business realizes that the worst is over for banking and housing - the economy is starting to recover. In the face of this, all the Fed’s previous monetary machinations begin to ‘kick in.’ Under those conditions, gold is again advancing. All the money that was created during 2007 to counteract recession now acts as an ‘overflowing punch bowl.’ The global economy is ‘on fire.’ Under these conditions, gold heads sharply higher.

The one situation that could be bad for gold is when deflation takes over and there is a panic for cash in order to stave off bankruptcy. A variety of assets, including gold, would then be sold in order to raise dollars. But this state of affairs is rather unlikely while central banks are at liberty to create money out of thin air.

I cannot help but conclude that we have not yet seen the last of the yellow metal’s new records and that more excitement lies ahead. For starters, I will not be holding my breath for the all-time high of $850 to be breached. After all, platinum, which often leads gold higher, has already recently recorded an historic high in U.S. dollars.

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