What the US rate cuts mean for gold

published 23 January 2008

Sometimes it's important to filter out the noise.

There's been rather a lot of it over the past week and it can be very distracting. One of the best ways of doing this is to look at a long-term chart.

The gold price is measured in dollars, but unless you are spreadbetting it, dollars can be a distraction to the UK investor.

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We in this sceptr'd isle are using our hard-earned, rapidly-declining pounds to buy the metal of kings, so let's take a look at how gold has done in sterling.

Some regard the Mona Lisa as a beauty, but others will derive far more aesthetic pleasure from the chart below. Gold began 2007 at about £315 per ounce and ended the year at about £455.

That's a 44% gain. No leverage, no individual company risk, no country risk, no bank risk, but nevertheless a hedge-fund defeating return.

Now let us turn our attention to the noise. The first loud noise was the dramatic declines in stock markets worldwide which began a few months ago, accelerated last week and climaxed on Monday. Make no mistake: the eyes of traders everywhere were bleeding. So much so that there was huge pressure on the US authorities to do something about it. Fifty minutes before market opening the Ben and Hank Show came on air and we got the cut the bleeding eyes of the traders were craving. "Knackers to inflation" was the inference.

US Treasury yields were low enough to allow the Fed could get away with this unprecedented move and it was the move everybody wanted. Make no mistake about it, we were looking down the barrel of a major, major crash. I had fellow traders phoning me up going, This is it. This is the big one.' One said his strategy for the day was to lie on his office floor in the foetal position, twitch violently and foam at the mouth.

I dread to think what would have happened had the Fed not cut rates. But cut them they did and disaster, for now, has been averted. Shortly before Bearded Ben's announcement gold slid down to its 1979 high (now support), gave it a last kiss goodbye and rocketed up t$o 890. We can expect gold to resume its flight towards a thousand. I am more confident than ever that my target of $1,150 will be met by the spring.

We can also expect rallies in stock markets. But, though potentially sizable, these will just be bear market rallies. The underlying problems have not gone away. They are largely a result of too much easy credit and authorities are attempting to cure the malaise with more easy credit. The next time we have to face the music when this rally peters out - the Fed will have even less ammo with which to act. Goodness, there is even talk of them cutting when they meet next week! But it is clear the Republicans do not want a crash during an election year, for they will surely lose, and it seems they are prepared to do just about anything, including selling their green-backed daughter down the river, to avoid one.

I wonder what the Saudis were saying to George Bush last week behind closed doors about their declining dollars. Whatever was said, the Fed yet again made it very clear by their actions yesterday that they are prepared to sacrifice the dollar. They are going to try and inflate their way out of this mess. The long-term consequence, in my opinion, is going to be continued deflation in the things which we buy with debt houses, stocks etc and inflation in the things which we buy with cash oil, food, metals etc.

You build wealth by growing things, mining things or making things. You do not build wealth by fiddling the figures.

Junior miners continue to underperform woefully and are, mystifyingly, in the most vicious bear market. It's possible they are bottoming now. What will it take to re-ignite interest and speculation in this potentially electric sector? Thousand dollar gold? High-profile takeovers? A major discovery? All three could well happen sooner than you think.