The following are slightly-modified extracts from recent commentary that appeared at The Speculative Investor web site.

Gold and the Dollar

We are constantly looking at a number of completely separate factors in an attempt to ascertain the future direction of the markets. We are particularly interested in situations where the fundamental, psychological, cyclical and monetary backdrops combine to strongly suggest a change in the prevailing price trend. When price action then comes into line with the other factors we can be confident that an important trend change, rather than simply a correction within a continuing trend, is underway. The US Dollar's performance over the past 4 months provides an example of several different factors coming into alignment (pointing towards a change in the major trend), with price action subsequently giving the necessary confirmation. The gold market provides another (and related) example, although 'price confirmation' has been minimal thus far.

The failure of gold to react more positively to the Dollar's recent fall is frustrating, but not entirely puzzling. We know that the gold market is manipulated and we know, thanks to evidence uncovered by James Turk, that the US Government has been involved in that manipulation. We also appreciate that the short position in gold is huge and that those who are short physical gold will try very hard to protect themselves from the debilitating losses that would result from a substantial rally in the gold price. This is why we think the gold price will reach its destination via a number of mini-explosions, rather than via a steady climb. Efforts to artificially limit the gold price in the face of a falling Dollar will create pressure that will periodically be released via short, explosive rallies.

Our contentions, over the past few years, have consistently been that:

1. Suppression of the gold price has only been successful because the investment demand for gold has remained low.



2. The investment demand for gold will rise in parallel with a fall in the investment demand for the US Dollar and Dollar-denominated assets.

Further to a) and b) above, the gold price will rise in a falling-Dollar environment, regardless of any attempts to manipulate it lower.

We should certainly find out, within the next few months, whether the above analysis is right or wrong.

The Big Picture

When we get involved in watching the daily fluctuations in the financial markets it is easy to lose sight of the big picture. It is, therefore, often useful to take a couple of steps back to try to gain some perspective.

The Dollar peaked in late October 2000. At that time we thought a major trend reversal, rather than simply a 'blip' within an on-going trend, was about to occur. There is no change to that view. We suggested that the Dollar Index would likely drop to the 105 level by January, in a test of the up-trend dating back to the October 1998 bottom. The low, so far, has been around 108 (down from a high of 118.9 on Oct-26).

The gold price and the XAU bottomed in November, but of greater significance is the all-time high in the gold/XAU ratio that was reached during the Oct-Nov period last year. In the past whenever the XAU has reached an extreme low relative to the gold price, a major rally in gold stocks has followed. The 20% bounce in the XAU since that time does not qualify as a major rally.

The combination of the Dollar embarking on at least an intermediate-term down-trend and an all-time high in the gold/XAU ratio strongly supports the idea that gold stock prices are headed much higher over the coming months. As such, we remain very bullish on gold stocks and believe the gold sector offers great profit potential for 2001. We are, in fact, far more bullish on gold stocks than we are on the gold price itself because gold stocks will need to rise substantially just to bring themselves into line with the current gold price. Prior to the last few months the most recent example of gold stocks being as undervalued, relative to the gold price, as they are today occurred at the end of August 1998. During the ensuing 6 weeks a 10% up-move in the gold price led to an 80% rally in the XAU.

There is, of course, risk associated with any trade or investment. Robert Prechter, the Elliott Wave guru, has a long-standing target of $200 for gold. We think this target is ridiculous, but there are two scenarios under which it does become plausible. The first would be a move, by the largest official holders of gold, to sell a substantial portion of their remaining reserves. The second would be a worldwide deflationary collapse resulting in massive capital flight into the perceived safety of cash US Dollars and US Government debt. Both scenarios are possible, but highly improbable.

At this stage it looks to us like gold reached its ultimate bear-market low in August 1999 and then made a higher low in October 2000. However, if we are wrong we have no intention of riding gold down to $200 and thus have an exit strategy that involves 'protective stops'.

Steve Saville
Hong Kong

10 January 2001

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