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Wait for gold to decouple from base metalsPaul van Eeden On Monday, Cathy Minehan, the President of the Federal Reserve Bank of Boston, commented on the risks that the slowing housing market could pose to the US economy. She was speaking at a meeting of the National Association for Business Economics and a survey of the Association's economists revealed that they, too, expected the US economy to post below-trend growth for the rest of this year and into 2007. The Bank of Japan also kept its interest rates unchanged without giving away any clues as to when, or if, it might raise interest rates again. There is some speculation that weakness in the Japanese economy could deter the BOJ from raising interest rates in the near future and this dampened enthusiasm for base metals further. Most investors (both individual and institutional) are reactionary, and when they read about negative sentiments such as these they react by giving sell orders to their brokers, which is precisely what happened this week. US money supply (as measured by my own estimate of M3) increased by 8.4% over the past twelve months. Current gold inflation, which is mine supply as a percentage of all above-ground gold (all the gold that has been mined to date), is around 1.6% per annum. That is why the gold price continues to rise against the US dollar over time - it is as simple as that. In the short term, however, exchange rates and investor sentiment also have to be brought into account and it is mostly they that cause short-term volatility. But in the long-term, the gold price in any currency will rise by an amount equal to the difference between its inflation rate and the inflation rate of the currency you price it with. My model of the gold price (based on the inflation rates of gold and the US dollar) puts the gold price at around $900 an ounce with the difference between the current gold price and $900 being accounted for by an over-priced US dollar. For gold to rise from $600 an ounce to $900 an ounce requires the dollar to fall, on average, by 35%. The Organization for Economic Co-operation and Development (OECD) said earlier this year that the dollar had to fall by 35% to 50% in order to balance the US current account gap. I don't know how they came up with those figures, but they correspond very well to my own expectation of how much the dollar should decline. If the gold price is going to rise to $900 an ounce then gold at under $600 an ounce is starting to look attractive again, but there is still downside risk in base metals and until the gold price uncouples from base metals prices I would not get too aggressive on the buy side. But gold will decouple, because unlike base metals, its value (and long-term price) is not dependent on economic growth. *** Special Event: Conferences: Paul van Eeden To subscribe to Paul van Eeden's Commentaries please visit www.paulvaneeden.com
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