From the PFG Best Research Team:
As gold continues to ascend into record unknown territory, media pundits continue to talk about inflation. However, as we pointed out earlier this week, gold’s move into this rarified territory is more due to its use as a hedge against currency “instability” than it is a comment on inflation.
The continual declining value of the US dollar (USD), and the rising price of gold, is a comment on the USD’s fall in popularity as the world’s currency as well as global investors’ increased risk appetite. In reality, some on the street are playing gold as if it is the new currency of choice more so than a sign of inflation. If gold’s rise were an inflationary indicator, the Ten Year Note market would have moved significantly higher.
Let’s take a step back and address the continued shout-it-to-the-mountains calls for inflationary concerns. Plain and simple, inflation is not a near-term concern for the US economy; we are still very much in a deflationary state, just look at the massive sales throughout the retail sector, the lack of available credit and the job market. However, developing nations and those nations related to commodity production are and have been experiencing different pressures than the US.
As the USD declines, commodity prices rise simply due to the fact that the majority of commodities are priced/traded in USD. Additionally, as the USD loses value, that causes opposing currencies to appreciate. This creates two issues: Rising costs associated with commodity-dependant industries and non-USD currencies appreciating too quickly and above targeted ranges.
The situation created by rising commodity prices does affect developing nations more than the US. However, if the USD is able to stabilize or the US government decides to change their stance to that of creating a “strong dollar policy”, we could see commodity prices fall and fears of overseas inflation subside. Interestingly enough, the US could use this change in policy as their first step towards repositioning the American economy instead of initially raising interest rates.
With the weak USD, some countries can only sit and watch their currencies appreciate so long before they have to intervene; look at Russia’s involvement in October 7th’s auction. One way for international central banks to alleviate the appreciation of their currencies is to purchase US assets, such as bonds, to increase their USD reserves and help reduce their currencies’ values. If this policy becomes common throughout numerous nations, it could help strengthen the USD. We actually feel this trend could be one of the reasons why we’ve been experiencing lower US yields over the past month, especially on the long end of the yield curve.
At the end of the day, currencies trade off of numerous fundamentals but most notably the underlying interest rates. So, until the US raises its interest rate, it will be hard for the USD to reclaim its dominance. We can only hope for a slow transition towards a stronger dollar policy as our economy begins to stabilize. But in the short-term, this environment could represent opportunity in the form of a trade:
Trade Recommendation: Sell Gold
Our opinion is that gold should be sold on a short term basis. Our indicators point to the fact gold is overbought and a near term trade might be appropriate. This can be executed through the futures markets, selling gold futures, and also through the options’ market:
Let’s start by selling a November options spread which expires in 21 days; essentially this trade is profitable if the market stays in the same place, if gold moves higher but does not close above 1080 or if the gold market moves lower.
Sell Nov 1080 Call
Buy Nov 1110 Call
For more aggressive traders, let’s enter a futures trade:
Sell Dec Gold Future @ 1058.50
Set buy stop to offset @ 1064.70
Sell Target @ 1032.40
Eaven Horter, firstname.lastname@example.org
Mark Melin, email@example.com
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.