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What's Going on with Gold and the Dollar?

An e-mail we just received from a subscriber:

"Hi guys, I know this message may be the sign of the bottom, but I cannot take these markets anymore. I am getting these terrible stress headaches watching my gold & silver stocks and I am selling out my positions tomorrow morning."

Another e-mail from a non-subscriber:

"Why do the gold stocks keep declining? Do you think the government is behind it?"

It seems that blood is in the streets in the land of gold and silver mining equities. Additionally, the US Dollar has roared back ferociously ever since being featured on the cover of Newsweek. So what's going on?

We were at a second hand bookstore the other week and purchased a copy of Martin Mayer's The Fate of the Dollar which was published in 1981. The book, written during the height of the Dollar crisis, offers a detailed history of US Dollar policy in the twentieth century. Where it gets interesting however, is in the play by play account of the gold bull market during the 1970s and how it affected the public's perception of money. During the rocky 1970s, there were many times when the Dollar would mount vicious bear market rallies in the face of worsening fundamentals. Most of the time according to Mayer's book, these rallies were artificially created by central banks of various countries. So if you believe that humans tend to behave the same way throughout history, then it only makes sense that the current Dollar rally (in the face of record trade deficits) has been influenced by central banks.

There are many reasons why it is in everyone's interest to keep the Dollar from declining in a straight line. The Europeans are only weeks away from voting on an EU constitution. Sensing populist resistance to any further loss of sovereignty, perhaps the Eurocrats in Brussels do not want to rock the boat with a stronger Euro. After all, a stronger Euro means less exports and higher unemployment which could result in clashes between European federalists and anti-federalists. Tying monetary policy with electoral politics is well documented in Mayer's book, so don't think history couldn't repeat. After all, why do you think incumbents hoping for reelection beg for low interest rates?

At times like these, we think it makes sense to step back and look at the big picture. The fact is that the Chinese are months (perhaps weeks) away from revaluing the Yuan which would have the effect of unloading a bunch of dollars into the open market. Also, don't ignore the trade deficit numbers - they will matter at some point - no country has ever consumed its way to prosperity. Finally, guys with the great track records (ever heard of Warren Buffett?) continue to move out of the Dollar. It might be a good time to pick up a few gold coins and mining shares.

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