Soaring Gold and a Sinking Dollar Signal Trouble Ahead

As measured by the price of the forward December contract on COMEX, the value of gold is up nearly 30% -- over $300 per troy ounce -- since last October, and it recently closed at a record high (in nominal terms) of $1,374 per ounce.

Hardly unique among commodities, gold has had lots of company in the trading pits. Silver is up by 32%, and even the price of coffee is on the rise -- not only on the exchanges, but at Starbucks too.

Gold's unflinching rise has caught many traditional equity investors off-guard, and some are even angry about it. Warren Buffet's investment partner Charlie Munger, who lists to the right, counterbalancing Buffet's leftist leanings, has remarked recently that even though gold seems to be working as an investment theme, those who invest in it are "jerks."

But several financial seers -- Marc Faber, Jim Rogers, and Peter Schiff among them -- saw gold's rise as inevitable and linked it directly to the massive ongoing issuance of cheap money by the Federal Reserve and other central banks. When easy money from Alan Greenspan's Fed caused the dot-com bubble to first inflate and then burst, these observers realized that the Fed would launch another easing campaign to birth another investment bubble: housing. Once the housing bubble burst, even more violently than the dot-coms, there was little left to inflate. The Fed decided to think outside the box, and through quantitative easing, it became the buyer of last resort of treasury bonds and toxic mortgage debt. In so doing, The Federal Reserve has managed to achieve the perverse distinction of throwing fuel on a fire that it itself ignited.

The markets are clearly horrified by the Fed's direction, and traders are rushing out of the dollar and into any asset not under the control of the Fed. Since Bernanke tipped his inflating hand in Jackson Hole in August, the dollar has fallen over 8% against the broad basket of currencies constituting the dollar index. Both the Canadian and Australian dollars are effectively at parity with the U.S. dollar for the first time in history, the Swiss franc is trading at an all-time high against the dollar, the Singapore dollar has reached a level versus the greenback not seen since 1982, and the Japanese yen strengthens almost every day and sits at a fifteen-year high. Even the European central bankers have halted the printing presses since their recent experience with financial Greek tragedy, and as a result, the Euro buys 1.4 dollars, the highest levels of the year.

There is a sense that not even the Fed believes that its policy of purposeful inflation will stimulate either investment or growth. After all, what good did their previous version of quantitative easing accomplish?  Despite historically low interest rates, foreclosures in September rose above 100,000 for the first time, and monthly initial jobless claims rose to 465,000.

So cash is rushing into gold as gold fulfills its historic role as inflation hedge and alternate currency in a world where signs are pointing to the dollar relinquishing its hundred-year reign as the global reserve currency. Interestingly, except for a few cranks, very few market actors believe that gold and its precious relatives are anywhere close to forming their own new asset bubble.

Gold cannot be created by central banking fiat. It remains scarce and difficult and expensive to find and mine. Indeed, by most historic markers, gold and silver are still wildly undervalued. Discounting for inflation, gold would have to exceed $2,000 per ounce to equal its previous peak value reached in 1980. Goldman Sachs has recently revised its upper price target for the metal to $1,650 for 2011. Average historic ratios of the Dow Industrial Average and the price of gold would argue for $1,800. And other models can justify still higher numbers.

We are on the precipice of a currency crisis, a completely man-made catastrophe. The men who orchestrated it first created a central bank in 1913 that eventually took us off the gold standard and devalued the purchasing power of our currency by 90%. Later, others in the 1930s and 1960s erected a viral, insatiable welfare state and attempted to feed it and keep it at bay with high taxes and waves of financial, stock, and real estate bubbles. Then we elected Obama, who decided to go down in history as the great destroyer by unleashing several trillion-dollar bubbles at once. We know the names of all of his co-conspirators and hope to punish them severely in a few weeks.

For those who had the foresight to accumulate gold (or silver or platinum), there might be some comfort in knowing that you managed to stave off complete financial disaster by funding your own domestic central bank. The sobering truth, however, is that history provides very few examples where dramatically rising gold prices do not point to unnerving instability or disaster.

Claude can be reached at