Gold: A Paradigm Shift in Global Finance

By: Elliot Turner

This week, gold continued its powerful breakout through the $1,000 level. In assessing the strength of gold relative to other commodities--including other precious metals and crude oil--we can clearly see a divergence in preference of gold.


Silver performed well in the early part of gold's breakout, yet while gold continues to forge new all-time highs in U.S. dollars, Silver has failed to follow suit.


Additionally, although the GDX (the index of gold miners) outperformed gold on its first leg higher, and historically outperforms gold to the upside, the price of gold now leads that of the miners. Fundamental analysts insist that the rush into gold stems from the declining dollar and the threat of future inflation; however, there is reason to believe that something larger is at play here. Gold is well above where it was when the dollar reached even lower valuations in July of 2008.

To that end, when India purchased 200 tons of gold from the IMF for approximately $1,043 per ounce we received further confirmation as to the greater significance of gold's move. Export driven economies who accumulated and continue to accumulate dollars in their capital account surpluses feel the need to diversify their dollar denominated holdings. India outbid China--another export driven economy with huge U.S. dollar holdings--in an effort to snatch up half of the 403 tonnes of gold offered by the IMF. Earlier this week, the Russian Central Bank jumped on the bandwagon and indicated it would begin purchasing gold, despite the fact that just last month the country thought about selling gold reserves.

All this action points to a fundamental paradigm shift in global finance. Countries reliant on exports will seek a global basket of currencies and assets to replace the dollar as the world's reserve currency. This movement should continue regardless of whether the dollar reverses higher. Maintaining such a high proportion of national wealth in one denomination generates too much instability. Previously, China invested portions of their $2 trillion in currency reserves in assets including Freddie Mac and Fannie Mae debt, and Blackstone equity, among other investments, in order to seek a return on their capital. Had the U.S. government not nationalized Freddie and Fannie and saved the bondholders of the GSE debt, China might have suffered catastrophic losses. Although gold continues to make new highs, the paying up in price seems reasonable in contrast to the alternative. Gold offers stability in an interconnected, highly unstable global economy.

Should gold continue to move higher, it deserves watching whether these export economies continue to buy large quantities of the precious metal and how aggressive they become in their purchases. The move by India is a MAJOR step in the direction in favor of modernizing the Bretton Woods economic paradigm. In August 2009, globally renowned economist Joseph Stiglitz wrote an article not only arguing in favor of such a fundamental shift, but also pointing to why it is inevitable. As traders, this is a development that we must follow.

Regardless of the underlying catalyst for the move in gold, traders continue to profit from the breakout using technical analysis. In many respects, the move in gold has followed textbook technical patterns, allowing for excellent risk/reward opportunities entries and exits.

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