Credit Crunch & Current Gold Prices

Credit Crunch & Current Gold Prices

Greg Silberman CA(SA), CFA (Retired)

Gold is truly the schizophrenic of the investment world. The worse the market looks, the better the fundamentals underlying Gold and the harder Gold and Gold Stocks sell off.

Let’s start with the fundamentals:

The Yield Curve continues to widen as short rates come down faster than long term rates - investors are rushing to the safety of short term treasuries:

Figure 1 - Yields on 10yr notes rising quicker than 3 month bills

This is a sign of an economic slowdown - lower inflation is forcing long bonds rates down but Fed induced short rates are coming down quicker in order to stimulate the economy. This is Bullish for Gold as it causes speculators to borrow short and lend long i.e. the money supply increases.

Credit Spreads have continued to widen. So much for rate cuts supporting the market. Widening Credit Spreads are an indication of a flight to quality. Investors are moving to the safety of Government Bonds and away from lower rated debt e.g. Corporate and Mortgage paper. A flight to safety is good for Gold.

Figure 2 - Credit Spreads as measured by the performance of treasury vs. investment bonds have widened significantly

And finally Gold has trumped industrial metals indicating a slowdown is benefiting Gold over economically sensitive industrial metals.

Figure 3 - Gold outperforms against economically sensitive industrial metals during a slowdown

So what’s wrong? If the indicators are so bullish, why the sell off in Gold Stocks?

Gold Stocks are stocks after all and will be impacted by the general market sell off. However, the main reason behind the sell off is a stronger Dollar. The Gold market is grappling with the fact that lower foreign interest rates are causing the US Dollar to rally.

We are of the opinion that the US Dollar is in a long term Bear market. It is politically acceptable to let the Dollar fall and keep the stock market levitated rather than visa-versa. As we’ve seen over the months, a falling Dollar has supported asset markets (including Gold) through lower interest rates. That said, based on the monthly picture and our Fibonacci projections, we think the current down leg in the Dollar has further to go.

Figure 4 - US Dollar index (monthly) more downside after a brief rebound

Based on our Fibonacci projections we feel the Dollar will rebound to resistance at 80 and then reverse lower to make an intermediate low of 65 towards the end of 2008.

Gold Stocks and the stock market will struggle for the rest of the year (New York Stock Exchange on the Edge) as the Dollar rallies. Then, sometime in January, Gold Stocks will lift off the floor along with the Stock market and begin discounting the next down leg in the Dollar (probably before the Dollar makes its correction high of 80).

When the Dollar finally makes new lows Gold Stocks particularly the Juniors will be flying!

More commentary and stock picks follow for subscribers…

Greg Silberman CA(SA), CFA
greg@goldandoilstocks.com
December 16, 2007

I am an investor and newsletter writer specializing in Junior Mining and Energy Stocks.

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This article is intended solely for information purposes. The opinions are those of the author only. Please conduct further research and consult your financial advisor before making any investment/trading decision. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.