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U.S. Dollar Strength, Deflationary Concerns, Fail to Halt Gold’s Rise

We live in interesting but paradoxical times. Today, oil prices reached their lowest levels in five years, with WTI dropping below US50 per barrel; the U.S. dollar continued its multi-month rise, closing at 91.383 on the USDX; while spot gold caught a strong bid, closing above $1,200 despite its generally inverse price correlation with U.S. dollar strength. Gold stocks also showed some strength with the Gold Bugs Index up 2.6%.

GBugsIndexJan5

Perhaps even more strange is the fact that this is all happening in what can only be described as a highly deflationary economic environment.

The DOW plummeted almost 330 points today in what could well be a harbinger of more bad news to come. In the past few years these sudden drops have been good news for the “dip buyers” whose strategy on balance has left them well rewarded. Someday – maybe sooner than people think – the orchestra will fail to show up after the intermission and all hell will break loose.

The currencies of resource-based economies including Canada’s continued to fall, with the Loonie tumbling below $US.85 for the first time since May of 2009. Canada’s currency often trades as a “petro dollar” with the majority of its oil production coming from oil sands operations in Alberta, the majority of which are probably losing money at today’s prices.

Lower oil prices are a mixed blessing and the savings at the gas pump are arguably a two- edged sword: While it’s noticeably cheaper to fill up your tank at your local service station, the destabilizing influence of lower prices on major oil producers has potential consequences that are readily apparent but generally hard to quantify.

Russia’s oil wrought economic crisis could easily end in yet another sovereign default, one that would certainly roil global markets. The shale boom in the U.S. is also at risk with oil prices trading below $60. Oil and energy investment has been a huge part of U.S. growth momentum in recent years and has been funded by cheap money.

Noting that US junk bond funds have played a major role in bankrolling the U.S. shale boom, Reuters, the international news agency, recently reported that “in recent weeks, prices of some of these bonds have collapsed as oil prices have tumbled by a third since June to four-year lows, sapping energy companies’ revenues and raising doubts about their ability to repay the debt.”

Despite the collapse in oil prices, international producers, most notably Saudi Arabia, have steadfastly refused to curtail production while others, including Russia, have in fact threatened to increase production, presumably to make up in volume what they are losing in pricing. This form of brinkmanship will end badly for everyone including the U.S. and its historic Cold War adversary, Russia, run by the enigmatic and unpredictable Vladimir Putin.

CrudeOilPriceChartPerhaps anticipating higher gold prices, gold mining stocks have shown some strength in the past week, albeit following a brutal sell-off of producers and junior explorers alike.

Threats of a Greek exit from the Euro zone should a leftist party win the upcoming Greek election have hammered the Euro into a nine year low against the U. S. dollar, turning many investors to safe havens including U.S. treasury bonds and gold.

Bloomberg reports that hedge funds are stepping back onto the gold bandwagon as political turmoil in Greece and government actions in Asia helped send prices to their biggest monthly advance since June.

“Bullish wagers on the metal increased for the first time in three weeks and have more than doubled since mid-November, U.S. government data show. Short holdings dropped for the sixth week in seven. Bullion rose for a second straight month in December,” Bloomberg said today. It would also¬† appear that investors are also looking at gold as a hedge against currency depreciation.

Gold market action in the next few months could well define the trend for the remainder of the year.

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