Earlier in the summer, DailyFinance noted that a weakening dollar was the main contributor to rising energy prices, as the underlying supply/demand fundamentals were poor. However, the dollar's impact extends far beyond energy, and its fall has coincided with a rally in the broader market. The combination of these two factors has sent the CBOE Volatility Index ($VIX), a gauge of investor fear, to lows not seen since pre-Lehman times. Taken together, the actions of the dollar and the VIX send conflicting signals about the future of another hot commodity investment: gold.
The Powershares U.S. Dollar Index Bullish (UUP) is down more than 12 percent since March, testing its 52-week low. Gold is typically bought as a hedge against a falling dollar, and the rapid expansion of the monetary base by the Federal Reserve has led many to anticipate that gold would soar to new highs. Instead, gold has settled into its tightest three month trading range since September 2007. One possible reason for this is that, even as the dollar loses value compared to other currencies, the fear that has filled the marketplace has also dissipated. If the historical relationship holds, one of these indicators is wrong, and that could spell big profits for investors who correctly identify which one.
Graham Summers believes the VIX is "broken" and investors are showing too much complacency, especially considering that bellwether companies like American Express (AXP), General Electric (GE), and United Parcel Service (UPS) are fighting double-digit drops in revenues. Despite the poor results -- and outlooks from those companies suggesting that no turn in the economy is at hand -- Summers told DailyFinance that the market has "thrown fundamentals out the window." He went on to note that momentum traders have pushed the Nasdaq ($COMPX) to an overbought level that typically presages a decline of at least 15 percent.
"This market is ripe for a complete repeat of 2008," as investors realize that consumers have not deleveraged and unsustainable levels of government spending have been the primary factor propping up the economy. Summers believes that, as investors grow to realize that private business is still on life support, gold is poised to rally more than 30 percent to $1,300 per ounce.
Just as DailyFinance highlighted one key economic indicator that's not improving, Summers points to another transportation metric that's actually deteriorating -- the Baltic Dry Index. The BDI, a measurement of the cost to ship various commodities between global ports, has fallen 29 percent in the last two months. This suggests that demand for key raw materials, such as coal, oil, and basic industrial metals, has weakened substantially of late -- perhaps enough that it will derail the much-anticipated second half economic recovery, sending the markets down and gold to new highs.
James Cullen edits and writes at CollegeAnalysts.com. He is the Vice-President of the Boston College Investment Club, which owns GE, but has no personal position in the stocks mentioned above.