1 The Firecracker Report
November 29, 2009Move Over King Dollar for Gold is Emerging as the New Flight-to-Safety Trade, asit Begins to Decouple from the Dollar
Off late we have been noticing an interesting phenomenon. Gold seems to be decouplingfrom the dollar. Now before we delve into this, we digress to examine some noteworthypoints about gold.Over the last several months, gold prices had moved in a near perfect inverse correlationwith the dollar - when the dollar went up gold declined. Most analysts attributed thisbehavior to either 1) the dollar carry trade, in which investors borrowed cheap dollars topurchase risky assets such as stocks, high yield bonds and commodities (including gold) or2) secret gold price manipulation by the Fed, to keep the legitimacy of King Dollar as theultimate
“
risk-free
”
asset
…
a.k.a. the flight-to-safety trade. We believe that some of bothhas been going on, but in any case what is really interesting is that most investors viewedpaper dollars as the
“
safe
”
asset and gold as the
“
risky
”
one. As the year has progressedand Bernanke has revved up the printing press in full, the idea of the dollar as a safe assetis seeming more and more laughable.Watching television in America one might be led to think that this lack of faith in gold as asafe haven, is an all pervasive universal phenomenon. Actually it is not - it depends onpeople
‟
s regional and cultural conditioning. We call it generational knowledge. In countrieswhere there is generational memory of a paper currency crisis (think Asian financial crisis of 1997 and the Russian debt default of 1998), the populations are inherently distrustful of their fiat currencies and respective governments and these people are socially conditionedto invest in gold. To them gold is the
“
safe
”
asset. As we pointed out in our recent article,
there is one country in particular where this penchant for buying gold has culturally existedfor
centuries
- India. Buying gold is programmed into their DNA, and
billions
of Indianswill happily attest that it has served them exceedingly well for generations.So why the inherent distrust for gold in the West? Are a billion Indians not enough to provegold
‟
s superiority over paper currency? Guess not - and mainly because ever since the Westwent of the gold standard, its populations have been routinely fed the
“
paper currency isking and gold has no intrinsic value
”
slogans. This has of course been done on purpose,because for the fiat paper currency system to work, people
‟
s confidence in the paper needsto be maintained. More over in the absence of any major currency crisis in the developedworld, this idea has firmly taken root and the generational knowledge of gold as theultimate safe-haven has been lost.That is until now. Since the financial crisis hit, Americans had been hearing a smattering of astute analysts advocate for gold. However it was not until the Indian Central Bank
‟
s Nov 3
2 The Firecracker Reportpurchase of 200 tons of gold that the bell really went off in investor
‟
s minds. With onestroke, the Indian Central Bank legitimized gold once again as an alternative asset class.And with this gold began showing increasing signs of decoupling with the U.S. dollar. As weshow in the table below, the November correlation between gold prices and the USD/EUR Fxrate fell to its lowest level of -54%. For most of the previous 6 months (between May andOctober) this correlation had hovered well north of -80%.In a clear break from the past, on several occasions in November whenever the dollar hasrallied, gold instead of falling has continued its steady march upwards. Now we doacknowledge that one month
‟
s statistical data does not make a trend, and furtherobservations are necessary. However there is one more piece of data that lends weight tothe decoupling thesis: gold
‟
s behavior during the Dubai financial crisis.If gold was just an investment vehicle for the global commodity carry trade, then during theDubai financial crisis, gold prices should have crashed as the risk trade was unwound andinvestors rushed to the safety of the dollar and Japanese Yen. Indeed both the Asian andU.S. equity markets took a huge beating, as the carry trade unwound and the dollar, yenand Treasuries rallied. But the action in gold told another story (please see chart belowcourtesy of Kitco Gold). After holding up extremely well in Asian trading on Thursday (while
U.S. markets were closed), gold initially declined in early Friday trading but unlike equities,managed to smartly recovered from its early morning losses.
Monthly Correlation between USD/EUR Fx Rate and Gold PricesNovember (post Nov 4) -54%
October (until Nov 4) -71%September -80%August -86%July -92%June -76%May -92%
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Gold Decoupling From the Dollar and Emerging as the New Flight to Safety Trade
Off late we have been noticing an interesting phenomenon. Gold seems to be decoupling from its negative correlation with the dollar. Is gold on the path to replace king dollar a...
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| Upload Date: | 11/30/2009 |
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