NEW YORK (Dow Jones)--In recent months, it's been the golden rule, so to speak: the dollar keeps hitting historic lows and gold keeps hitting historic highs.
It's a relationship that typifies the gold market in times of flux for the value of the dollar, given the simple fact that the global spot price of gold and gold futures are priced in dollars. Because of that, a weaker U.S. currency makes the precious metal cheaper to non-U.S. investors. In essence, what's bad for the dollar - namely the threat of inflation and aversion to perceived U.S. investment risks - is great for gold.
On Monday, spot gold prices traded at their highest levels since 1988, above $450 per ounce and many market participants are now eyeing the $460/ounce and $500/ounce levels as the next major goals. The euro, meanwhile was at $1.3271, not far from the all-time high of $1.3329 that it hit on Friday.
But despite the fact that the inverse lockstep has held up so well, it's not a certainty that it will continue to guide markets. As both the dollar's selloff and gold's rally reach new extents, differences are emerging in just how far out on the limb speculators have gotten in each respective market and just how much more they can stomach.
Since the beginning of 2002, gold prices have climbed over 50% from around $285 an ounce. The primary driver behind that has been the dollar's cross-currency spiral lower, particularly the 50% the dollar has lost since the euro traded below $0.89 at the beginning of 2002.
Sporadic periods of uncertainty relating to terrorism fears and the war in Iraq, as well as concerns about the potential for a return of inflation, have also steadily drawn buyers to gold and away from the dollar.
Divergent Paths
Following such huge market moves, however, the profiles of each market don't necessarily look the same. On one side are the gold bugs, whose recent bout of love for the yellow metal has been nothing short of speculative, given that physical supply and demand for gold haven't changed substantially to justify the price rally.
In fact, Ray Nessim, president and chief executive of Manfra, Tordella & Brookes Inc, the largest physical precious metals dealer in the U.S., said his company are seeing investor selling rather than buying at these levels, further supporting the theory that speculators are pushing the rally.
Others agree the gold market may be running out of steam. "By any measure this market is heavily overextended so I think we're in for some serious consolidation if not a correction at some point soon," argued Peter Grandich, a gold specialist and editor of investor advisory newsletter 'The Grandich Letter.'
By the very nature of the leveraged gold trade, those traders have essentially borrowed the dollars to buy gold, and a reversal of the trades would both help the dollar and send gold lower.
But in contrast to the purely speculative gold rally, the dollar's declines have been based on the fundamental concern that foreigners will become less willing to fund the enormous U.S. current account deficit.
While much of the dollar selling has been speculative, a large portion has been due to so-called `real money' segments of the markets - asset managers and non-U.S. corporations - that are making longer-term decisions to allocate out of dollars or repatriate dollar-based earnings before the dollar falls even further.
"During the summer months, amid the range trade, some real-money segments of the market accumulated increasing amounts of dollars as they waited to see what would happen," said Thomas Stolper, currency strategist at Goldman Sachs in London. At this stage, they clearly want to get rid of this exposure," which will lead to continued dollar selling.
Speculators betting against the dollar are only being emboldened by that flow of those funds out of dollars, said Stolper. "There is not much concern about any form about a substantial correction," in the dollar, he said.
Year-End Divergence?
For investors, the question will increasingly become one of which market is more vulnerable to an immediate correction. While sentiment on Wall Street is overwhelmingly for the dollar to continue weakening, analysts in the gold market are a bit less sanguine about the prospects for further one-way trading in gold.
"I'm a roaring gold bull and have been for some time, but right now I have to say the next $20 move in gold could go either way,' said Grandich.
One of the most immediate risks to the relationship could come as the end of the year approaches, and investors decide to what extent they'd like to lock in the gains they've made by being long gold, short dollars, or a combination of the two.
Given that hedge funds have been the primary drivers of gold's gains in recent months, their `calendar-centric behavior' may be the determining factor in the timing of any gold price retreat.
"Hedge funds have been the heaviest buyers of gold recently, and they work within calendar years so we could see some year-end profit taking coming through in the next few days," argued Grandich.
For both markets, some degree of profit-taking is to be expected as funds cash in their chips for year-end reporting and profit distributions. But such a move could pose a bigger risk to gold than for the dollar, since gains based purely on speculation would be more susceptible than gains made on an combination of speculation and ongoing real-money flows.