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Why The New Year Will Be Good to Gold Bulls

Lance Lewis

December 23, 2009

Note that the HGNSI collapsed 14.3 points yesterday to 10.9%, a level last seen August 21-28 when gold was in the $940s. So, we now have yet another reason to expect gold to rally soon, but if that’s to occur then the squeeze in the dollar needs to end because all that matters for gold (or at least “apparently” all that matters based on the action of the past three weeks) is when the year-end squeeze in the dollar ends (see the chart below, which is self-explanatory).

Perhaps that turn in the dollar is finally beginning to occur today. It certainly doesn’t help the buck any that Canada’s Finance Minister Jim Flaherty is out saying that China and Russia may be poised to buy loonies in order to shield their reserves against the US dollar’s decline.

As for why this rally in the dollar began here in December (which is typically the dollar’s weakest month of the year on a seasonal basis), it still boggles my mind. It’s not a deleveraging squeeze like in 2008. Best I can tell, it’s nothing more than "year-end" position flattening into dollars, which is still what the majority of the world measures performance in.

First, the dollar bulls claimed the dollar should rally because the better jobs data signaled a Fed tightening right around the corner. Even after the Fed pretty much poured cold water on that theory, the new theory became that we were seeing a flight to the dollar in order to avoid sovereign credit issues in Greece and Spain (never mind that there are equal or greater state credit risks in the US).

But that supposed flight has actually been into the dollar and out of every currency on the planet, not just the euro. It’s not as if investors were selling the Australian Dollar or the Canadian Dollar due to credit fears. And if sovereign credit fears were truly spiking, then why hasn’t gold been soaring in all currencies this month? And why in the world isn’t US debt (which is “the best” according to these people proclaiming these theories) rallying if the US dollar and US sovereign credit are ports in the storm? T-bonds are falling like stones!

None of these explanations really explain what has happened over the past three weeks, and I continue to believe that’s because there has been no fundamental reason for it. The dollar’s rally has simply been a short squeeze that initially began as bets were intensely laid on a Fed tightening (even though they were wrong about that) and has since continued to feed on itself due to the proximity of year-end and the fact that the measuring stick by which most money managers get paid is the dollar.

We can even see this phenomenon play out every 24-hour cycle in the way the dollar has been heavy overnight every day for the past several weeks, but it then firms during US trading where US money managers are busy chasing it, even as the Treasury bond market increasingly accelerates to the downside.

That brings us to my point, which is that the more important question may be not will there be a year-end rally in gold and the foreign currencies, but what happens to the dollar when 2010 arrives and this year-end support is suddenly removed?

The answer is that we’ll be left with a situation in which there are a vacuum of shorts underneath the dollar amid massive speculative long positions that aren’t in fact supported by any fundamentals (or even a deleveraging squeeze like the one in 2008).

That’s the recipe for an extremely rapid decline in the dollar in my book (despite January normally being a strong seasonal month for the buck), which also translates into an equally rapid rise in gold based on the way the market continues to trade the two off of each other.

In short, whether gold and the dollar turn before the end of the year or not, the payback in the first week of January for gold bulls (and dollar bears) should make the past three weeks of pain more than worth it, even though I can see how it might not seem that way at the moment, especially if a professional has watched their annual performance fee collapse nearly every day for the past three weeks.