Somewhere after paying over $100 for a tank of gas, $35 for a haircut, and $15 for a fast food sandwich, it dawned on me last week. The euro is terribly overpriced against the dollar.
I wrote about this extensively last week, arguing that, because of a litany of taxes and fees, and due to overselling of the dollar, the euro zone is excessively expensive in dollar terms. Clearly there needs to be an adjustment.
Taxes are simply another form of inflation, and one that has been felt acutely in Europe; politicians impose new taxes, and ’stuff’ becomes more expensive. Employees demand higher wages to maintain some semblance of their living standards, and in the end, all prices have gone up without any real value having been created.
If the current administration gets its way, the same thing will be happening soon in the US. A national sales tax will likely be introduced, along with a host of other income and luxury taxes, pushing up the prices of everything, from gasoline to haircuts to fast food.
Gold is generally regarded as a proxy on both safety and inflation; when price levels of ’stuff’ go up, the price of gold rises accordingly… often outpacing the rise of inflation due to increased concerns about safety.
Gold’s rise this year has been more about safety than inflation; price levels generally show stable or declining prices around the world, but institutional money has voiced significant concern regarding investments that were once considered safe.
Dubai, Greece, Latvia, Ireland, Spain, UK, etc. all give investors a lot of reason to worry. Ironically, when things get really bad in the rest of the world, investors rush into the US dollar as the ultimate flight to safety.
I know I don’t have to tell you that this line of reasoning is utter nonsense. Institutional money managers realize it too– the prospect of loaning money to the largest debtor in the history of the world for 30-years at less than 5% is certifiable lunacy.
That’s why so much sovereign and institutional money flows into shorter-term treasuries– they want to sit on the sidelines for a short period of time, and they’re willing to lose on the yield in order to guarantee the safety of their funds.
Naturally, the chief reason that Treasuries are considered safe is because they are backed by the full power of the US government’s printing press. Investors are wise to this trick, and smart money will not be fooled into longer term bonds unless there is another financial cataclysm.
As I survey the situation, I’m convinced that gold is nowhere near peaking exactly for this reason. In a flight to safety, institutional money still flows into the dollar. Gold will not truly break out until there is a bifurcation in investors’ mentality regarding safety.
To put it more clearly, when worried investors start piling into gold instead of the US dollar to protect their assets, this is the sign that we are charging towards the top.
For now, it’s not happening yet, and that’s why I recommended going long gold against the euro– the euro has been overpriced against the dollar, and while gold has dropped roughly 5% against the dollar since I recommended this trade last week, it has risen 3% against the euro.
Despite its historic nominal highs, gold still has a long way to go before achieving this bifurcation. The idea that US treasury securities are safe must be eradicated from the investment community before it’s safe to say we have reached a top.
I know you have heard this before, but gold is way off its inflation adjusted highs. Most of the time people talk gold’s inflation-adjusted high in 1980. But if you want to get a better sense of gold’s potential, you need to go back even further.
The best apples-to-apples comparison of gold prices is in British pounds sterling (GBP); Britain is a much older country and historic gold prices exist in pounds for nearly 1,000 years.
Gold’s highest price was recorded in the late 1400s at an inflation-adjusted price of roughly GBP 1200 during what was called the ‘great bullion famine.’ The 1980 peak in sterling terms was about 30% lower than this. Today gold sells for less than GBP 700 per troy ounce.
The length of the present dollar rally, which technically started several weeks ago, is unknown. From the beginning of the meltdown in 2008 to the dollar’s peak earlier this year was about six-months. This one may be shorter, or if there is a great cataclysm, much longer.
One thing is inevitable, though, and that is the investment community’s eventual abandonment of the dollar as a safe haven. As such, from a fundamental perspective I have great difficulty playing this rally by buying dollars and dollar assets.
I’m sticking with the long gold/short euro position; gold may fall in dollar terms, but I expect it to stay stable and gain against the euro. I also intend on bargain shopping for long-term silver options; as a speculation, I prefer silver to gold as the ‘cheaper’ metal is still over 50% off its nominal high. Gold is less than 10% off its nominal high.
You can do this with long-term options on any of the silver ETFs, or if you have a futures account, you can buy call options for long-dated silver futures contracts like December 2011.
