The conventional wisdom is that the
rate cut last week by the Fed is going to
either send money hightailing it out of
the dollar, or cause inflation, or both.
Both of those possibilities would be
good news for gold prices according to
this thought process. But as usual, we
enjoy knowing what the conventional
wisdom is so that we can think the opposite.
One big factor arguing against a big
rally in gold prices is that too many people
still expect to see one. The Central Fund
of Canada (CEF) is a closed end fund
whose assets consist of gold and silver
bullion kept in storage. Its price moves
up and down with the prices of those
metals, but because it is a closed end
fund it trades at a premium or discount
to net asset value. The current
17% premium is way out of whack compared
to historical norms. Understand
that this means that investors are willing
to pay 17% more than the assets are
worth in order to hold a claim on those
assets, and these assets do not pay a
dividend nor have earnings. Gold prices
would have to go up to $372/oz to justify
this share price, and that is a level
not seen since November 1996. Somebody
is hoping pretty hard.
We know that the Dollar Index is falling
right now, due in part to the Fed’s
action. But we see a turnaround ahead.
Movements in short term rates tend to be
echoed 40 months later. This relationship
does not explain all of the Dollar
Index’s movements, but there is clearly
a correlation here. If the Dollar Index
follows this leading indication as it has
in the past, then we should see a spike
upward in the value of the dollar during
2003. That will put downward pressure
on the price of gold for as long as it
lasts. Following that rally, this leading
indication calls for a dramatic drop in
the Dollar Index during 2004. At that
time, gold should be able to do much
better. But the investors who have bid
up the share price of CEF will have been
scared back out of their bullishness on
gold and won’t get to enjoy it.
Bottom Line: Gold investors are still
too bullish for gold to be able to continue
higher here. The dollar should
rebound and draw money away from the
gold market.
