12/14/2011
By David Urani, Research Analyst

Wait, so Europe is going down the toilet, the very existence of the euro currency is being questioned and the global economy is looking very shaky. Wouldn't those all be good reasons to buy gold? You would think so, and in the past these are factors that have seemed to drive gold, among others. However, if you're a gold bug then the real bane of your portfolio right now is the dollar.

The Achilles heel of gold is the fact that it's priced in dollars. When the purchasing power of the dollar increases, then anything denominated in dollars effectively becomes easier to buy. That means that when the dollar moves higher, gold becomes cheaper because the amount of gold that one dollar could buy has increased. As you can see in the chart below, gold's movement is nearly a mirror image of the dollar (green line: dollar/euro rate, black line: gold).

As you may have seen, gold has made some especially large moves to the downside in the past couple of days, and that's because there are a couple of factors acting against the dollar. The first and most obvious factor is the drop in the euro. The EU summit held last Friday was billed as a meeting that would create solutions for the European crisis. Although there were some long-term backstops put in place, the market has decided that there still are no silver bullets for the immediate debt problems facing Greece, Spain et al. A couple of weak bond auctions from Italy and Spain haven't helped to alleviate those fears.

Secondly, the Fed failed to deliver more medicine to the markets. Although there were no explicit calls for more action by forecasters, the market was clearly let down when the Fed's meeting concluded earlier this week with little activity. In that back of peoples' minds, there must have been some hope that the Fed would at least hint at QE3, or some other sort of stimulus. Of course, we already know that Fed stimuli generally weigh on the dollar as the money supply gets increased. The perception that the Fed has become less dovish is impetus for the dollar to strengthen.

Lastly, all the recent news has sent the euro to a new 11-month low. With the euro having broken that key support point, that is adding a little extra momentum to the rising dollar.

David Urani
Wall Street Strategies

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