As this article attests, and as investors know well, gold is at a low for the year and the dollar is at a 2018 high. This is based in part on the customary inverse reciprocal relationship between the dollar and the dollar price of commodities. A strong dollar means low commodity prices and a weak dollar means high commodity prices.
This is playing out in markets for oil, natural gas, copper, coffee and many other commodities. Gold just gets lumped in as a commodity for this purpose, and the dollar price of gold is suffering along with the rest.
Yet, gold is not just another commodity; in my view, it’s not a commodity at all. Gold is money. Oil, copper and other traditional commodities are important generic inputs to other processes in manufacturing, power generation, and construction. By contrast, gold is really not good for much except as money. That makes gold a competitor with the dollar when a pre-panic flight to quality arises.
Investors fleeing emerging markets from Argentina to Turkey will run to dollar-linked assets such as Treasury notes and FDIC insured bank deposits. Gold usually qualifies as one of these “flight to quality” assets.
In such situations, there’s room for a stronger dollar and higher dollar prices for gold as flight capital runs to one or the other. But, there’s more to the story.
Before anxious investors can buy the assets they want, they have to dump the assets they have. That’s not so easy when your assets are Turkish government bonds or Argentinian peso stocks.
When investors are near panic, they don’t sell what they want; they sell what they can. If they already have Treasury bills or U.S. bank deposits, they sit tight. If they have local stocks and bonds, they may be stuck.
Gold is a unique asset because there’s always a market for gold. Investors looking for liquidity will sell gold not because they want to but because they can. Buyers know this and will offer lowball pricing until the last seller yells “Uncle.”
We saw this in the 2008 financial panic when gold prices initially fell along with stocks and bonds. Then a funny thing happens. As the last seller dumps gold, and as the panic drags on, a new group of strong hands comes in from the sidelines and starts to bid up the price of gold. We saw this in the super-rally in gold from 2009 to 2011 after the panic was over, but the desire for safe assets persisted.
Investors should not be discouraged by the price action in gold but should see it as part of a process whereby gold drops in the early stages of a panic and then rallies in the later stages. You should think of the recent low gold prices as a gift in the form of a lowball entry price. Investors who buy now will be richly rewarded when the inevitable rally begins.
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