Gold's Rise Above $400 Level Owes a Debt to the Dollar
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By PETER A. MCKAY
Staff Reporter of THE WALL STREET JOURNAL
As of 9:03 p.m. EST Tuesday, December 9, 2003
Gold's best friend lately has been green.
In recent weeks, helped by the weakness of the U.S. dollar, gold prices have surged, closing above the psychologically important level of $400 an ounce for the first time in almost eight years. Tuesday, it closed at $408.90 a troy ounce on the Comex division of the New York Mercantile Exchange, up $12.10, or 3%, since Thanksgiving. Over the same period, the dollar is off about 2% when compared with the euro, the yen or the British pound.
The reasoning behind the gold move is simple: As the dollar falls, more investors seek out the metal as a tangible store of value to replace dollars and other dollar-denominated paper assets in which they have lost faith.
Most Wall Street pros say the metal has likely registered its biggest gains of the current rally, which began in 2001. But they predict gold will still run at least a little higher next year. Gold is up more than 60% from its low of $255.10 an ounce in February 2001, and many of the 2004 forecasts being issued by trading houses lately include predictions of another 6% to 15% gain next year.
The major premise for most of those predictions is that the dollar will stay weak amid ballooning U.S. government deficits and low interest rates, boosting gold in the process. In interviews and in a recent research report, for example, Merrill Lynch's foreign-exchange strategists predicted a 10% drop in the dollar's value versus major currencies next year.
At the same time, other downbeat trends that have helped gold during the past few years are reversing. The stock market's swoon has ended, with the Dow Jones Industrial Average up almost 19% this year and the Nasdaq Composite Index up nearly 43%, leaving investors freshly attractive alternatives to buy in lieu of gold. Also, U.S. economic growth has been surprisingly strong, topping 8% for the third quarter, and unemployment is creeping lower. Even the Federal Reserve, a bit dour on the economy earlier in the year, had a mildly more upbeat statement on the economy after its policy committee meeting Tuesday.
Historically, an improving stock market and economy bode ill for gold prices. Some also worry that the high prices could encourage more production. But for now, most observers seem unfazed, expecting currency trends and continued gold demand overseas, especially in Asia, to keep the metal's price near or above its current, relatively hefty level.
"Near term, a $20 or $30 retracement in the gold price could happen at any time," said James Steel, New York-based research director for the commodity brokerage Refco. "But I think it will be short-lived because the fundamentals point toward higher prices."
Mr. Steel said he expects gold to trade between $425 and $440 next year, in part because its price and the dollar's value are beginning to reflect foreigners' waning political confidence in the U.S. since the Iraq war.
Indeed, some of the biggest increases in gold demand lately have been abroad. In the third quarter, gold demand leapt 12% in India, 5% in the Middle East and 2.4% in China, according to the research firm Gold Fields Mineral Services.
Jeffrey Christian, managing director of the research firm CPM Group, said he still sees reason to be bullish on gold, but cautiously so at this point.
He estimated that once gold prices rise above $375 an ounce, mining companies are likely to restart mines that were shuttered when prices were too low to justify production. Also, Mr. Christian said jewelry makers are likely to start making lighter pieces to keep their raw-materials costs low. Last year, he estimated there was a 12% decline in jewelry-related demand for gold, which is likely to be followed by a decline of 2% to 6% this year.
The other major wild card, Mr. Christian and other analysts say, is investment demand for gold, which has been particularly brisk since the terrorist attacks of Sept. 11, 2001, when there was a torrent of safe-haven buying. Last year, investment demand -- defined as demand for gold bullion, coins and medallions -- nearly doubled, as prices leapt 25%, according to CPM Group.
But, Mr. Christian warned, surges in investment demand usually last only a year or two, which means the current trend could reverse "at any time."
He said gold-price rallies above $400 have been sustained only twice during the past 25 years: 1979 to 1983, when gold traded as high as $825 an ounce; and 1987 to 1988, when it hit $497 an ounce. The first rally was driven by high energy prices, interest rates and inflation. The second was marked by a steep decline in the dollar and, of course, the stock market crash of October 1987.
"These were both particularly bad economic periods, so to think the price is going to do the same thing now, you have to build in some pretty pessimistic expectations about the economy," Mr. Christian said.
James Glassman, senior U.S. economist for J.P. Morgan, said he understands why investors' uncertainty so far has led to a higher gold price. But he also believes many analysts have been overemphasizing the weakness of the dollar. Rather, he believes the current foreign-exchange trends may be more of an endorsement of overseas currencies, especially the euro, than a marketwide repudiation of the dollar.
If foreign currencies continue to climb during the next year or so, Mr. Glassman said European central banks might raise their interest rates at some point, setting off a chain reaction that would effectively end the gold rally.
"You would think it's going to run its course pretty soon," Mr. Glassman said.
Write to Peter A. McKay at peter.mckay@wsj.com
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