This blog is written weekly by Dock David Treece, a registered investment advisor with Treece Investment Advisory Corp. It is meant to share insight of investment professionals, including Dock David and his father, Dock, and brother, Ben, with the public at large. The hope is that the knowledge shared will help individuals to better navigate the investment world.

Monday, September 14, 2009

Gold hits $1,000 an ounce – but can it last?

It recently has been relatively quiet in the markets, with the biggest news being gold’s fifth test of the $1,000 mark in the past year and a half.

While gold’s recent strength is certainly no surprise — we have been singing its praises for a decade — it is worth noting that this most recent advance towards $1,000 has taken place as money supply numbers released by the Federal Reserve (especially M2 and MZM) have actually been falling.

What this seems to indicate is that the Fed has taken action the past month to begin removing excess liquidity from the system that it injected last fall. It is doing so with the hopes of avoiding massive inflation once credit begins to loosen again and all that new money starts making its way through the global financial system.

So far, the Fed’s efforts to remove excess liquidity have not been totally successful, as gold has marched higher since this time last year, nearing $1,000 for the third time since then. It has done so as the dollar has fallen sharply on worries that the international community will make good on its promise to abandon the U.S. dollar as the world reserve currency.

This concept has been picking up steam since the financial crisis erupted in the United States last year, with the rest of the world being dragged into the pit thanks in large part to their substantial reserves in dollar-denominated holdings. During the past year, the reserve currency status of the dollar has been called into question by the likes of the G-8, the International Monetary Fund and, most recently, the United Nations.

The varying dynamics of this year and last have sparked an interesting debate about whether gold or United States Treasury bonds provide a better “disaster hedge.” In a Sept. 9 Wall Street Journal article (“Is Gold the Right Recipe for Disaster”), Peter Eavis addresses both sides of this argument.

Frequent readers will undoubtedly guess where we tend to stand on this issue. And for those who call us fatalists for preferring gold, I’ll point to the 38 percent decline in the value of 30-year Treasury bonds year-to-date, versus the 14 percent advance in the price of gold bullion.

Strangely, other commodities seem to lack the luster in gold’s recent performance. Crude oil has been trading at $70/barrel lately after dipping briefly into the upper 60s.

This is likely because of the relatively slow summer travel season this year, as well as decreased speculation, which played a major role in oil trading more than $120 a barrel this time last year.

Even more significantly, natural gas remains very cheap, trading at slightly more than a third of its price this time last year. This is even more remarkable considering that we are heading into what has been predicted by “Farmers’ Almanac” to be an extremely cold winter. Some may remember that even last year, which was not as bad as this year has been forecasted, saw Russia cut off the flow of natural gas into the Ukraine due to shortages in Eastern Europe.

As we head into fall, a historically weak period of stocks and strong time for gold bullion, all of these developments have set the stage for what should be an exciting six months.

Between now and Christmas, the world markets will reveal a lot in the way of collective expectations about where our global economy is headed, and how it intends to get there.

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