Why the shaky US housing market bodes well for gold

The gold price has retreated from its spike to over $540 an ounce. But it won't be back down there for long. Cracks are appearing in the US housing market - that's bad news for the dollar, but good for gold...

The gold price is running strong that always makes me nervous and I instinctively brace for a correction. That's because markets move higher in fits and starts. While I believe that the gold price is going much, much higher it would be nave to think that we will get to the top in one long, smooth upward move.

I am not predicting that the gold price will correct, but I have already prepared myself psychologically for it to happen so that when it does, I will be neither surprised nor disappointed.

What the cooling housing market means for the economy

The real estate market has been fuelling the US consumer-driven economy for several years, and is now showing signs of petering out. Recently we saw that existing home sales fell, that inventory of houses for sale in the US was at its highest level in 19 years and housing affordability at a 14-year low. Meanwhile, pending home sales in October declined by 3.2% from September's level.

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During the first nine months of the year, investors accounted for almost 10% of all home mortgages. The Wall Street Journal reports that individuals are pulling back from buying homes and condos as investments, and that could accelerate the cooling of the housing market. This phenomenon is recent and is just starting to show up in national data.

You can tell when the real estate market is getting silly when individual investors buy houses with little, or no money down, in the belief that they are going to retire rich from the capital appreciation. This highly leveraged real estate speculation fails when mortgage rates rise and rental income no longer covers loan obligations. David Berson, the chief economist of Fannie Mae, reckons that home sales could fall by more than 10% over the next two years, largely because of the decline in investor demand.

We can also see investors heading for the exits when we look at condominium cancellation rates. In San Diego, cancellation rates for new condominiums rose 47% in the third quarter of the year versus the second quarter.

Why change at the Fed will mean greater volatility

Retiring Federal Reserve Chairman, Alan Greenspan, is worried. He has again warned Congress to restore federal spending caps and cautioned that the federal budget deficit will substantially worsen in coming years unless major deficit-reducing actions are taken. When Clinton was president the US had a budget surplus, not because he was necessarily a great president, but because the economy and the stock market grew so much that capital gains taxes swelled the Treasury coffers. If the real estate market softens up and the economy slows down, then tax receipts will decline and the federal budget deficit will soar.

While markets abhor uncertainty and ambiguity, the Federal Reserve is doing everything it can to become more obscure. The Fed has announced that it will stop producing the monetary aggregate M3. M3 is the broadest measure of money supply and, as such, our most reliable source of inflation data (changes in consumer prices can be caused by inflation but are not the same as inflation; inflation is simply an increase in money supply).

As the Federal Reserve prepares for a change in leadership, it is also preparing for changes in transparency. The Fed moved towards an increase in transparency over the past twelve years and has signaled its upcoming moves in the accompanying statements to its policy meetings since August 2003. Now it seems the Fed will make its policy less predictable just as Ben Bernanke -- who is an advocate of 'openness'-- takes over as Chairman of the Board of Governors of the Federal Reserve.

With less transparency into what the Fed is thinking we can expect more volatility in interest rates and bond prices. I suspect we will also see an increase in volatility in stock prices, commodity prices and precious metals prices.

What the falling dollar will mean for the price of gold

As long time readers of these commentaries know, I firmly believe that the US dollar has further to fall and that means the US dollar gold price has further to rise. A couple of weeks ago China's central bank executed a transaction in their domestic foreign exchange market that traders interpreted as a signal that the renminbi might be allowed to trade higher in the coming months. For the US dollar to fall in any significant way we will need to see the renminbi and the yen rise. The yen has had a hard time during the past year, but should the renminbi gain against the dollar I would not be surprised to see the yen strengthen against the dollar as well.

All of this bodes well for the gold price: a falling US dollar and increasing uncertainty is just the kind of stuff that gold bull markets are made of.

Last year I wrote about a small exploration company called Virginia Gold in my newsletter. The stock was C$2.57 at the time and it closed today at C$10.60 after Goldcorp announced that it is acquiring one of Virginia's projects. One could profit from the gold market by buying gold itself, or by buying gold mining stocks. I prefer to buy small exploration companies. If you would like to know what I am personally buying and selling you might be interested in subscribing to my newsletter: I tell subscribers which stocks I buy and which stocks I sell. Information about the newsletter is available at www.paulvaneeden.com, under the Newsletter section.

First published on Kitco.com (www.kitco.com)

By Paul van Eeden

You may also like to read: Is the bull market in gold finished? For more on the US housing market, see: Is the US housing market crumbling? Or go to our section on investing in property and housing for a full list of articles.

Paul van Eeden works primarily to find investments for his own portfolio and shares his investment ideas with subscribers to his weekly investment publication. For more information please visit his website (www.paulvaneeden.com). If you would like to read more from Paul, you can sign up to get his weekly commentary at https://www.paulvaneeden.com/commentary.php.