Intrinsic Value of Fiat Currencies Under Siege by Gold

Earlier this evening, I was chatting up an ex-Morgan Stanley colleague who has been an independent professional advisor for futures and commodities trading over the past 10 years and is quite active in the gold and energy markets. I mentioned to him that I was doing a comparative correlation analysis of gold to some of the major G20 currencies and he had the following to say:

“It’s the intrinsic value of fiat currencies that is under siege. If we’re in a flotilla and all the boats are sinking does it really matter whose goes down first? At some point, that just becomes a footnote in history. Do I think we go away from the dollar altogether? No. But you do have to be looking at clients’ real WEALTH, not so much the nominal value of their accounts. How’d you like to have 10 million Hungarian pengõs right about now?…”

By the way, my friend will be the first to admit that he is sometimes prone to drinking his own Kool Aid. In contrast, Hillbent is primarily concerned with determining the market direction of macro-asset classes and then drilling down to investment themes and/or individual securities that may be driving a particular capital market.

Gold’s Relative Strength Performance vs. Major Currencies

Below is a summary analysis table that depicts gold’s relative price strength performance versus a group of 12 major currencies. Note that I have used exchange traded funds in lieu of actual futures contract data, but each of these ETFs does a more than adequate job of mimicking the price movements of their futures brethren.


Relative strength of gold vs. major currencies and the S&P 500 benchmark index >>> Click to enlarge

While China has been slandered as a currency manipulator, the biggest culprit is actually the U.S. which has underperformed gold by approximately 107% as a result of its QE (quantitative easing) policies and global reserve currency status. Although the majority of currencies on this list have shown positive performance since the onset of the financial crisis in November 2008, their intrinsic value relative to gold merely shows them being part of the flotilla that is sinking less rapidly than the dollar. For added emphasis, I have also included data on the S&P 500 (SPY) to prove my point from a earlier post that Helicopter Ben’s piles of newly minted “Monopoly” money represent nothing more than Fed flatulence reflating a deflated stock market bubble. To be forewarned is to be forearmed, gentle readers.

Significant Portion of Stocks Outperforming Gold

Now, in an attempt to be objective about gold’s relative strength versus alternative stores of value for investors’ capital, I would like to mention that 151 of the S&P 500’s component stocks outperformed gold during this same period and that 114 of these beat gold by 25% or more while 41 of these exceeded the performance of gold by 100% or more.

Expanding this universe to the S&P 1500 (500 large, 400 mid, and 600 small cap companies), 512 stocks outperformed gold as 380 of them bested the shiny yellow metal by a margin of 25% or more and 181 of these by 100% or better. These numbers are pretty good odds and quite far removed from proverbial “needle in haystack” proportions.

The moral to this story is that one should not succumb so easily to the forces of pessimism, but instead appreciate that diligent investment research or access to the proper tools for such can indeed lead to superior and/or profitable returns. As a provider of decision support research for stock market investing, perhaps Hillbent is also guilty of drinking its own Kool Aid. In the end, we all do what we can and at the very least, what we must.

Current Outlook for Gold

So what’s the current status on gold? It has retraced already more than 161.8% of its bearish move from the March 2008 high to October 2008 low. A 261.8% retracement could elevate gold to approximately $1550 to $1600 territory (see chart below). Right now, gold is so ridiculously overbought in just about every imaginable time frame that I have not even bothered to include a stochastic indicator to illustrate this. However, fears of both inflation and deflation are driving investors frantically into gold and therefore we must respect the hyperbolic irrationality of the tape and allow weekly and monthly support and resistance pivot points to provide further clues.


Weekly Gold Chart as of 10-5-2010

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Gold’s Weekly and Monthly Support & Resistance Pivot Points

Other Bullish Catalysts for Gold

Should unprecedented amounts of QE persist, this will also continue to buttress gold prices. Another catalyst could also be the desire for emerging market central banks, e.g. China or India, to preserve their current ratio of gold holdings to increasingly expanding reserve assets, which by the way are relatively small in comparison to many developed countries. (See World Official Gold Holdings for September 2010.) In addition to this, I have high regard for the Daily Reckoning’s Bill Bonner and the Mogambo Guru connecting some intuitive dots and making a case for China to increase its gold holdings from 1.7% to 10% of its foreign exchange reserves.
Sustainability of Gold Rally

Lastly, I would like to address the sustainability of gold’s current rally by sharing Hillbent’s velocity price indicator (VPI), a proprietary leading indicator for future price action. Unlike other momentum indicators that rely upon the underlying price of a security or asset, VPI measures the supply-demand equilibrium price based upon volume segmented and weighted over various time frames.


Velocity Price Indicator for Weekly Gold Prices as of 10-5-2010

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Currently, VPI is forming an asymmetrical triangle and I suspect that a confirmation breakout above or below its boundaries will trigger a substantial move in gold. Supplementing VPI is a weekly price chart of gold’s upward bullish channel. The fact that velocity is trending slightly downward or at best only laterally indicates subtle signs of negative divergence and it is for this reason that my investment bias towards gold is somewhat cautious.

That’s all for now. Until further updates, remain Hillbent for the market direction…

Originally published at and reproduced here with the author’s permission.   

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