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In recent weeks a collapse in the U.S. housing market and a sharp decline in crude has helped dull the threat of inflation. However, what these events have also done is reignite fears of a U.S. dollar decline. Last week the dollar suffered its sharpest decline of 2006, and the price of gold responded positively. This action led many to conclude that the dollar is resuming its trend lower.
While gold’s attempt to transition from an inflation hedge to crisis hedge previously failed, making the transition to currency of choice could prove easier. After all, at a time when liquidity is the financial markets is, to say the least, excessive, gold remains the only currency that cannot be printed in unlimited quantities.
Are the COT statistics back in play?
Since September 1, 2006 net commercial short interest as a percentage of open interest has risen and fallen with the price of gold more than 80% of the time. Provided this trend (which is really a resumption of the 2002-2005) had been more firmly in place, October 10-24, 2006 would have been the best buying opportunity since May 31, 2005 (See Chart). Unfortunately with the COT statistics becoming less influential since late-2005, it was difficult to call the bottom beforehand.
What is missing from the latest gold rally is a massive spike in commercial short interest – a spike wherein the commercials attempt to mark a line in the sand. This point could have arrived last week, but will more likely not arrive until gold tries to rally through $700 an ounce and/or new highs. If the USD has further downside expect exactly that, and potentially fast.
The notable caveat with regards to timing gold’s next record rally is as follows: there can be no guarantee that the next financial crisis is going to negatively impact the U.S. dollar. The best time to own gold is when central bankers are growing increasingly aggravated with currency price fluctuations and/or when a sense of panic is controlling the decision making processes of investors and policy makers. For the moment, the world seems accepting of a weaker USD…
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