How is it gold, oil, and even the markets are rising in the face of a weak U.S. economy, mounting job losses and record foreclosures? Answer: They are all priced in U.S. dollars, which are declining in value.
Gold — A Matter of Math
On the rising price of gold, the numbers tell the story:
1) Historically, the supply of gold expands at an annual rate of about 2%;
2) Demand for gold also grows at an annual rate of 2%;
3) World population growth is 1.3% annually;
4) Gold reserves are depleting at 6% annually;
5) Gold is the historic "currency" of choice.
While supply (1) may currently be meeting demand (2), global population growth (3) and depleting reserves (4) will continue to put upward pressure on the price of gold. The fact that gold is priced in weakening dollars simply exacerbates the perception of increasing value. In spite of short-term volatility, the long-term trend for gold (5) is up.
Oil — About Preserving Purchasing Power
The oil-producing nations of the world hold pricing power. They can raise or lower the price per barrel by decreasing or increasing, respectively, oil production. Global oil consumption stands at roughly 86 million barrels per day, of which the United States consumes 25%.
When the U.S. buys oil from, let’s say, Saudi Arabia, we send them dollars and they send us oil. But as the value of the dollar weakens, it takes more of those dollars for Saudi Arabia to exchange into local currencies to pay its bills and salaries; for repairs, equipment, services and so forth. So what do they do? They move for a decrease in production, thus increasing the number of dollars it takes to buy that same barrel of oil.
For example, if the price per barrel were $76, a decrease of 1.5% in the value of the dollar would require an increase of $1 per barrel for Saudi Arabia to maintain its purchasing power. For those buying oil using euros, yen, aussies, kiwi, etc. (assuming they were stable), the increase in price would be of little- to-no consequence, because a decrease in the value of the dollar likely means an increase in value of other currencies against the dollar, offsetting the $1 price rise. In the end, Saudi Arabia manages to maintain its purchasing power across the currency spectrum through the dollar by use of production adjustments.
Therefore, as the dollar falls, we can expect oil- producing nations to act accordingly — regulating output in an effort to keep the dollar within a range that preserves their standard of living.
The Dow and the S&P 500 — A Multinational Phenomenon
By all standards, the companies represented in the Dow and S&P 500 are among the best in the world. With their size, scale and wherewithal to employ the best minds in the world, they have proven their ability to create, produce and distribute high-demand goods and services. It is for this reason they were selected to be components of the Dow and S&P 500. As has always been the case, strong companies are added to the indices as weaker ones are removed, which skews the indices’ bias toward the upside.
It used to be that the U.S. markets reflected domestic economic conditions and growth. Those days are gone. The Dow and S&P 500 now represent global economic growth.
For most of the companies, over half of their earnings is derived outside the U.S. Then, in a weak-dollar environment — which makes U.S. exports cheaper; more competitive — when foreign earnings are repatriated into U.S. dollars, the number of dollars is inflated, giving the illusion that earnings, though good, are exceptionally strong.
Fortunate for foreign investors, a weakening dollar also makes U.S. stocks cheaper for them, as they can buy more dollar-priced shares for the same amount of their currency. Increasing foreign demand is putting upward pressure on stock prices. If you are in the market, you will likely ride the tide higher. But the longer new U.S.- dollar investors wait to enter in the market, the smaller/more expensive the equity stake than that bought with foreign-investor currency.
It is for these reasons that as the dollar declines, gold, oil, the Dow 30 and the S&P 500 are likely to continue to rise in value.
