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Observations About the Gold Price Rally

December 10, 2005

With Gold soaring past $530 now, its highest level for a quarter century, some interesting things should be noted.

First, this increase have happened during a time when the dollar have risen against other mayor currencies. Usually there is a negative correlation between the dollar price of gold and the exchange value of the dollar versus the euro and the yen. But now gold have risen in price against virtually all currencies except the Brazilian real. While the gold price in dollars have risen 20%, the price in euros have risen nearly 40% and the price in yen have risen more than 40%. Another interesting thing to note is how this have been virtually ignored by the supply-side community. When gold prices fell in the late 1990s because of a combination of the increased foreign exchange value of the dollar and fears about central bank sales of gold, supply-siders like Larry Kudlow, Steve Forbes and Jude Wanniski went hysterical about the Fed's alleged "deflationary" monetary policy and demanded that the Fed inflated more. That's right, they called Fed policy "deflationary" at the height of the stock-market bubble when money supply was growing at double digit levels, using the then falling gold price as evidence.

Yet for some reason, I have yet to find a NRO article advocating a "tighter" monetary policy.

This despite the fact that Larry Kudlow as late as August this year wrote that "Should gold break out of its range and move, say to $450 to $500, that would suggest inflationary liquidity should be removed by additional Fed reserve-draining and rate-hiking actions. ". Now Gold is at $530, Larry....

What then are the prospects for the gold price? The argument against gold was summarized in a recent The Economist article denouncing "the barbaric relic". Yet with short-term interest rates around zero in most countries and with the risk that central banks will try to accelerate inflation to bail out governments and households from their record debt burden, gold seems like a good inflation hedge. And some "emerging economy" central banks have been considering increasing its gold reserves, most notably Russia, who have said it considers buying 500 tonnes (16 million ounces, at a price tag of $8.5 billion at current price) of gold.

While some form of short-term correction is possible -indeed likely- after the recent sharp rise, it therefore seems likely that gold could continue to rise until central banks is able to rein in inflationary expectations-or if they in an effort to attack the symptom rather than the disease try to supress gold prices with large-scale sales of gold reserves.

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