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''Currency Wars'' and the Price of Gold: What Does It All Mean?

The last several years have presented investors with many new and complicated twists and turns. There is far more information needed to make good investment decisions, yet, at the same time, there is a great deal of “noise” which can distract the investor while he or she attempts to seek good information to make good decisions. The current market environment presents just such distractions with the overblown media coverage of currency values and the price of gold. As I write this article the G20 group of countries is meeting to discuss the implications of the intervention by central banks into the international foreign exchange (currency) markets.

The impact of any news regarding the price of gold and or the fluctuation in the value of the dollar is immediately reflected on a daily basis in the prices for shares on the international stock exchanges. Therefore, it is not possible to simply ignore the news, although one may do better in the long run having done so. In order to best cope with the impact of gold prices and currency values on your portfolio, it is helpful to understand what it all means

The two charts below, depicting the price of gold and the value of the US Dollar (against other major currencies) respectively, together show an interesting pattern that is most important in understanding these inputs: as the value of the dollar has fallen, the price of gold (expressed globally in dollars) has risen. The problems which emerge as a result of the relationship between the gold price and the value of the dollar are the result of the reactions of other countries to this price relationship. In such a scenario, countries devalue their currencies to gain a competitive advantage in a world economy that has yet to fully recover from the global financial meltdown two years ago. Trade barriers are erected in response, hitting international commerce and reversing the economic recovery.


GOLD PRICE JANUARY 2010 TO OCTOBER 2010

Nations in Asia and other regions have been trying to stem strength in their currencies amid sustained weakness in the U.S. dollar out of fear their exports will become less competitive in world markets. At the same time, China's currency has been effectively pegged to the dollar, provoking an outcry that it is being kept artificially low and giving China's exporters an unfair advantage.


U.S. DOLLAR VERSUS MAJOR CURRENCIES 2010/MONTH BY MONTH

Most countries vie for international trade as the primary means of increasing their Gross Domestic Product (GDP), which is essentially the benchmark for their economic strength. The GDP of the USA has been weak for the last two years, and has only recently started to stabilize. Countries such as China have also recently experienced weakening GDP and as a result look to expand exports even further. However, if the dollar continues to weaken it will result in their goods costing more for US buyers, and purchases naturally slow further.

All of these factors contribute to the “noise” referred to earlier. At the end of the day, investments in shares of a company or in the corporate bonds of a company will yield returns commensurate with the ability of management to meet the goals and objectives of the firm. While the goals and objectives may be influenced by what takes place in the international currency market or by the movement of the price of gold, nothing will overtake revenues and profit margins as the overriding indicators of corporate health.

I don’t want to minimize the importance of currency fluctuations to a US based company who transacts large amounts of international business. Such a company most assuredly needs a risk management program which protects them against any adverse changes in currency values while they are engaged in international transactions. As investors, we can read financial statements of such companies and ascertain whether they in fact subscribe to effective risk management strategies. As for the price of gold, it should not be of concern unless we happen to be invested in gold bullion and or gold mining stocks. Again, in such instances we will gain assurance for ourselves that the company we are investing in has taken effective risk management action to insure both their acquisition costs and eventual sales revenues. Therefore the analysis remains as to what is their profit potential, not what are the political implications of the price of gold or the value of the dollar.

In summary, while all of the hoopla about gold and the dollar makes for interesting reading, it should not impact our focus in seeking out the best investment alternatives for our portfolios.

©Patrick J. Catania 2010
The views and opinions expressed herein are solely those of the author and do not necessarily reflect those of Baxter Credit Union, its Board of Directors, or its employees. The author is responsible for the content. Readers should consult with, and seek professional advice from their own attorneys, accountants, and financial advisors with respect to their individual financial needs and circumstances.

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