Gold and Dollar

I have seen two comments in my previous post asking me for the reasons for the rising gold prices. Thought I will give my answer as a post rather than as a reply in the comments section.

Historically, Gold has always been found to be a safe bet whenever there is an economic downturn. People have a psychological feeling that the yellow metal is a safe haven in troubled times. And they are correct.

In the current scenario of global financial meltdown, there is hardly any other option available for the investor. He doesnt see much logic in investing in Stock market which is at rock bottom currently, the real estate has been badly hit, banks and financial institutions have lost their credibility and also the interest rates are so low, it doesnt make sense to lock your money in bank savings.

So what is the alternative? Only gold. Apart from the retail investors, the institutional investors are also buying gold in large quantities as they do not trust the valuation of any other asset. Added to this, the oil prices are at a rock bottom. Again traditionally, gold prices are inversely linked to oil prices.

Finally, the production of gold has stagnated during the past few years. Supply constraints and demand increase obviously means rise in prices of gold.

But I guess, we have reached the peak of the curve at least for the time being. You can see some stabilization in the near future at slightly lower prices.

Dollar story is different. Technically, the dollar should have weakened in view of the huge US Treasury deficits and the economic bail out package of $ trillion which is mainly funded by printing dollars. But various countries are flush with dollars and with Euro weakening, these countries are hoarding dollars in the short term as keeping the investment in Dollars has been a comfort zone for many.

But beware. Dollar is fundamentally very weak now. Once these countries see the futility of hoarding dollar (that has resulted in less dollars in circulation) and starts opening up their strings, and once the newly printed notes as bailout package is actually in ciculation 3 months down the line, you will see a sharp crash in dollar's exchange value. With the United States grip over global economy dwindling, it is unlikely that US can browbeat other countries to support their currency. Only thing that is preventing a dollar collapse is the utter mismanagement of Euro and the fact that Yen is also under severe pressure. China and India have a vested interest in keeping the dollar rate artificially high, as they depend extensively on the export income.

My advice - This is the time to sell gold and book the profit. If you have dollar holdings, liquidate them, and stay away from US Dollar in the medium to long term.