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Should Gold Investors Worry on Dip Below $900 on Dollar Strength?

Commodities / Gold & Silver Apr 25, 2008 - 04:38 PM GMT

By: Andy_Sutton

Commodities Best Financial Markets Analysis ArticleWhen in doubt….Fundamentals - There appears to be a need for reassurance right now. A three-day rally in the Dollar has sent Gold below $900/oz. and Silver below $17/oz. There are whispers of currency market intervention, gold market intervention and talk of a Dollar rally. Rest assured, any rally will be a countertrend rally, most likely brief, and mean almost nothing in the grand scheme of things. Ironically, history suggests that the Dollar will rally, based on the unavoidable fact that we are now in a recession. I believe that history will rhyme, but not repeat. The fundamentals to support a sustained Dollar rally simply are not there. Moreover at a fundamental level, nothing has changed. Let's review the major themes and check our scorecard.


US Debt Load

Debt is one thing we do not have to look far to find in the United States these days. You can find plenty of it at any level of government or by taking a walk in your nearest shopping mall. Debt weighs heavily on the value of a currency because it hinders viable economic growth. Debt must be paid back, meaning that at some point future growth must be sacrificed in order to pay off creditors. We might just now be getting to the beginning of the sacrificing. We have certainly been good at putting it off. The debt load on future generations of this country is staggering. The mainstream media generally chooses to ignore the enormity of this situation, preferring to state the government's obligations minus a few small items like Medicare and Social Security. The real number, at last check was somewhere north of $55 trillion.

Unfortunately, the problem with exceedingly large numbers is that they lose relevance and our ability to comprehend them is lost. To get an idea of how much $55 trillion dollars is, lets send a typical American family of 4 to the mall. We'll make the assumption that they spend $50,000/hour as a group. To spend a million dollars, it would take them 20 hours. To spend a billion dollars, it would take them 2.28 years. To spend a trillion dollars, it would take them 2,283 years. And to spend $55 trillion, it would take them over 125 thousand years. It is still pretty hard to comprehend, but at least it puts some kind of scope to the issue.

Perhaps the biggest problem with the unfunded liabilities of the United States is that we really don't know how big they will be. Net Present Value calculations use assumptions about interest rates (or in this case, the rate of inflation) and small differences between those assumptions and reality can result in huge changes in the final numbers. The point is that we face a staggering burden moving forward and this burden is no secret. It virtually guarantees that we will need to create massive amounts of money to pay this bill. That will continue to weigh heavily on the value of the US Dollar.

Economic Growth

Another factor contributing to the value of a currency, absent backing by a tangible asset, is the growth of the underlying economy. Of late, US economic growth as measure by GDP is slowing to a crawl. The most misleading part of how GDP is reported is that nominal growth is discounted for inflation resulting in real growth. Herein lies the problem. Inflation numbers are drastically understated, demonstrated by the fact that over the past six months in particular, while food and energy have risen by double-digit percentages in many areas, the headline CPI has amazingly remained benign.

This distortion results in an overstatement of GDP and therefore economic growth. For Quarter 4 2007, GDP growth stood at .6% while the GDP price index was a paltry 2.4%. It doesn't take a stretch of the imagination to see negative growth given the obviously understated inflation values. As the credit crisis and indebtedness at all levels continue to weigh on economic growth, that weight will in turn come to bear on the Dollar.

Monetary Growth

Above all, the continued acceleration of monetary growth tells the story behind record prices in oil, gasoline, various food items and not-so-ironically, the fall in the US Dollar. The more money we create, the more things will cost BECAUSE the Dollar is worth less; not the other way around. M3 growth has risen to a record high. Potentially the only saving grace for the Dollar is that virtually everyone else is also debasing currencies. Whenever a currency runs up too fast, that country's leaders voice concern first, then demand more appropriate valuations.

This is tantamount to your boss telling you that you're working too hard, that your performance at work is too strong and that you need to ‘revalue' your efforts. It should be a valuable barometer of the times that nobody wants a strong currency. Everyone wants to be weak so they can export to the American consumer. Here's a news flash folks: the American consumer is broke and is so broke in fact that a handout of over $168 billion has been approved by Congress to try to encourage some spending. More than likely though, the majority of that money will end up either at the grocery store or the filling station.

Trade Deficit

Our trade deficit, building for years now, has resulted in the parking of several trillion dollars in overseas central banks. These central banks understand the folly of keeping all the proverbial eggs in one basket and seek to diversify themselves. Unfortunately, to do so in a meaningful fashion means to spend those dollars on tangibles, buy US assets, or attempt to sell Dollars and Treasuries on the open market.

This selling is putting considerable pressure on the value of the Dollar. The recent fall in the Dollar has done nothing to stem our trade deficit, and in all likelihood will make it worse by driving up the cost of imports that we rely on heavily. In that regard a recession would be beneficial in that it would serve to lessen demand for imports and stem the flow of dollars overseas.

In Summary

Much of the recent mini-rally in the Dollar has been due to action in the Euro. German consumer confidence and technical profit-taking have been attributed to the recent short-term pullback. The European Central Bank and the leaders of various EU countries have also been calling for intervention. The Euro has come a long way in a short time. The general consensus seems to be that it is fine for the Dollar to lose its value as long as it does so in an orderly fashion. Looking at a chart of the Dollar Index, it is relatively easy to make out the step-like pattern in the decline over the past 2 years. Sustained rallies have not existed, Period. The evidence supporting the thesis that this ‘rally' will be short-term in nature is immense, while evidence to the contrary is nearly non-existent.

By Andy Sutton
http://www.my2centsonline.com

Andy Sutton holds a MBA with Honors in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics. His firm, Sutton & Associates, LLC currently provides financial planning services to a growing book of clients using a conservative approach aimed at accumulating high quality, income producing assets while providing protection against a falling dollar. For more information visit www.suttonfinance.net

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