Greenback's strength is deflating gold price

Given the concern about global inflation, the price of gold should be soaring. Instead, it dropped $36.50 (U.S.) yesterday to $828.30 an ounce, the lowest since Christmas Eve.

The latest decline brings the drop since July 18 to a hefty $126.70 or 13.3 per cent.

The recovery in the U.S. dollar against major global currencies, including the euro, is weighing on the gold market because bullion is priced in U.S. dollars. The U.S. dollar touched the highest level since Feb. 26 against the euro during trading yesterday before finishing up $1.50 per euro.

The speed of the fall in gold has caught off guard even those expecting short-term weakness. In mid-July, Martin Murenbeeld, chief economist at Dundee Wealth Management Ltd., said gold could fall through $900 if there were no new major crises but he didn't see it dropping below $850, which was where a technical support line came in.

In his latest comment, written last Friday before this latest slide in gold prices, he admitted he didn't anticipate a fall quite as dramatic as has occurred. And he noted that gold stocks on the Toronto Stock Exchange, judging from the TSX gold index, have fared even worse than the precious metal itself. The index has slumped 24 per cent since mid-July.

Gold prices are being pressured by a number of factors, including technical. Mr. Murenbeeld noted that gold appears to have broken the uptrend that dates back to the start of the financial crisis last August. And he added that the fact gold prices didn't rise as high during the Fannie Mae/Freddie Mac crisis as they did during the Bear Stearns Cos. Inc. crisis suggests the financial crisis was beginning to lose its punch with respect to gold. (Gold peaked at an intraday high of $1,032 on March 17, the day JP Morgan Chase & Co. agreed to take over the deeply troubled Bear Stearns.) "Presumably, if the financial crisis moves into the background, hard to imagine, then gold could pull back to its uptrend, which currently lies just below $800," he said. The reference is to a second uptrend that commenced in 2005.

Bullion prices have also been depressed by the more than 4 per cent rebound in the U.S. dollar against the euro this month, driven by attention to economic woes in Europe and Japan, rather than good news from the U.S., as currency strategists at CIBC World Markets Inc. noted. The decline in oil prices is a further contributing factor. Crude prices have tumbled from a record $147.27 a barrel on July 11 to $114.45 yesterday. Many investors use the ratio between the two commodities as a rough guide to determine whether either is oversold or overbought.

Nick Majendie, chief investment strategist and money manager at Canaccord Capital, noted in his report last week that the ratio between gold and oil has averaged 15 times over the past 38 years. "Any time the ratio has got down to 10 times or under, it has recovered to at least 15 times within a minimum of three years," with one exception, he said. The ratio at the time of the report was 7.4 times. The ratio has been 7.5 times or less only three times since 1970.

"What is so significant about the gold/oil ratio going below 7.5 times is the subsequent performance of gold and gold stocks over the ensuing 12 months," Mr. Majendie said. "If gold bullion rose by the same amount as in the previous two periods, the implied price per ounce would be $1,330."