The Canadian market continues to set new highs. On the back of a commodity boom, most recently lead by gold. Are we looking at US$700 per ounce gold? Some analysts think so, because they believe the US dollar will weaken.

Same old story… really. Gold has value as a commodity. It generates enthusiasm as a currency hedge. Specifically, hedging against a decline in the US dollar.

Ultimately, for gold to rally, you have to believe that paper currency is losing credibility. Of course, you also have to believe that the world would be willing to accept gold as a currency to transact business. Personally, I have never been able to line up those two positions, and therefore, have never been a big long term fan of gold.

From my perspective, if you believe the world is facing a catastrophe, then buy a farm. At the end of the day we all have to eat, and currency – whether paper or bullion - is nothing more than a medium of exchange.

So long term, gold is not a growth story. Although it does, from time to time, have value as a trading vehicle. As we have seen recently with Canadian gold stocks; namely Goldcorp (symbol G) and Barrick (ABX).

The recent rally has been supported by the positive short term view on gold bullion prices. But that short term view may have more to do with grade 10 math, than a potential catastrophe.
Think about it this way. Gold is valued in US dollars. If the US dollar is weaker, and gold simply retains its core value, then by definition its price will rise. A weaker US dollar could very well take gold to US $700 an ounce.

Will that be good for gold stocks? The answer is twofold. On the one hand, there will be a speculative bump up in gold stocks as traders weigh the short term potential for bullion prices. We have probably seen that already. On the other hand, if Canadian gold stocks are to continue in rally mode, more has to happen.

I would draw your attention to my post on May 17th (Gold Stocks Tumble – See Archives) where I talk about the how the US / Canadian dollar relationship impacts the bottom line of Canadian gold mining companies. That would be at play here.

The ideal scenario if you are playing gold companies is to have the US dollar show signs of weakness against all world currencies except the Canadian dollar. In that light, the weaker US dollar will positively impact the price of gold, and a stable Canadian / US dollar relationship will enhance the bottom line of Canadian gold companies.

If the rally we have seen so far is based on that position – i.e. weak US dollar, stable relationship between the US and Canadian dollar - then this would be the time to hedge your bets; i.e. buy puts on G or ABX, or implement a covered call write on stock you own.

If you believe that to date gold stocks have simply reacted to the initial speculation surrounding bullion prices, without taking into account the US dollar / Canadian dollar issues, then there will be more to come. If you buy that scenario, then buy September at-the-money calls on G, or ABX, or XGD and hold on for the ride.