Long Term Perspective
Gold is a special metal. It has long been considered a hedge against inflation even though it has not always kept up with inflation. Gold is also considered a safe-haven investment in times of uncertainty such as war, economic, financial and political turmoil. Yet, over the past several years, more than one central bank announced its intention to sell some of its gold reserves. Could gold be losing some of its luster?

Despite all its attributes, some Fed officials still consider this a primary indicator of inflationary pressures. However, if gold prices rise because of political turmoil, this doesn't mean that inflation is around the corner. Thus, it is very important to consider all factors that can cause gold prices to fluctuate. In the past ten years, one can make the case that gold prices fluctuated with the dollar exchange rate. Indeed, notice that gold prices fell when the trade weighted dollar increased, and conversely gold prices rose when the trade weighted dollar fell.

Actually, a declining dollar can indeed be inflationary because prices of foreign-produced goods become more expense to U.S. consumers and businesses. By looking at gold prices in combination with other key indicators one can more readily interpret the reason behind the gold price fluctuations.

Economists expect that the foreign exchange value of the dollar will not remain strong - and could decline again in 2006. While interest rates are higher here than many foreign countries, and our economic growth is stronger than in many foreign countries, we still are facing record trade deficits.

Short Term Perspective
Gold prices have firmed somewhat recently but still have not regained their highs, reached in mid-May. Gold prices have risen over concern over the decline in the value of the dollar.

The foreign exchange value of the dollar has declined in recent months in tandem with expectations of Fed no longer tightening while central banks overseas have been lifting rates. When investors believe that the Fed will raise rates or overseas central banks will cut rates, the dollar appreciates. When investors believe that the Fed is done raising rates or foreign central banks will raise rates, the dollar declines in the FX market.