Gold & The Dollar Are Reaching A Critical Point

fromThe World Complex blog, via Zero Hedge:

Here at the World Complex I have been using gold x USDX (i.e., the gold price in US dollars per ounce multiplied by the US dollar index, divided by 100) as a proxy for the value of gold mined by companies not operating in the US. Assuming that their expenses are in some local currency, the cash flow of such companies can be improved either by a rising dollar (gold remaining constant) or a rising gold price. In fact, a rising dollar may be preferable, as when the gold price rises sharply, such companies are often hit with special “windfall taxes”–something I have yet to see when it is the dollar which rises (hopefully nobody gets any ideas about that).

There is a lot of excitement in the gold space in the past few weeks. As we saw over a year ago, there has been a breakout of the gold x USDX from a sizeable triangle.

The above chart lends itself to a couple of investment theses. One is that a lot of people seem to make a New Year’s resolution to buy a lot of gold, as there is a notable move in the index at the beginning of each of the last three years.

With all the excitement of the last few weeks, it is time to take a closer look. We are at an important point in at least three important respects. At present, gold x USDX is at 1203.79. The peak in the index hit during the move last year was 1229.93. I would submit that the present peak has to exceed last year’s level, or else it is just another lower high.

Here is a comparison of the performance of gold vs copper over the past six years (both are multiplied by USDX, gold is US$ per oz, copper in US$ per pound). The way this is plotted, wherever the two curves intersect, the gold-copper ratio is 400. Right now, gold is about 600x the price of copper. Historically, a ratio this high is uncommon–we last saw it briefly in 2009.

Ordinarily, I would say the above chart is a little scary for goldbugs, as it would seem to predict a drop in the price of gold (or a rise in copper, which seems a little unlikely in this economy). Your expectations will vary depending on your overall investment thesis. If deflationary forces grow stronger, this ratio could very well rise further, just as we are seeing in the gold-silver ratio. While Americans don’t seem to think of gold as money, it looks as though someone does. If your hypothesis is that central banks are going to pull out all the stops to fight deflation, your future predictions depend on whether you believe they will be successful.

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