Gold and the U.S.$ Today

By Julian D.W. Phillips
Nov 23 2007 11:23AM

www.goldforecaster.com





This week saw the $ cross the $1.48 line to the € heading for $1.50 after the U.S. markets closed for Thanksgiving. It then bounced after the London market had opened on Friday. We do expect a bounce, but not for long as a secondary phase of the crisis comes into play. What crisis, you may well ask? It is the sub-prime crisis/credit crunch/$ crisis as it spreads into the global economy [as well as inside the U.S. of A.]

The first phase is the onset of the crisis, together with smoothing words to calm markets, but to no avail. The second phase is when there is public recognition that there is a crisis, followed by all involved coming together to give the impression that the crisis is being resolved. This phase precedes watching the system begin to actually break down despite the superficial efforts of global monetary authorities to the contrary.

Are we there yet? The global credit crisis hit Asia like a tsunami hits the shore there for the first time this week, triggering a massive run for cover as investors fled their holdings of dubious fixed interest investments.

Another big Capital Tsunami hits

Yields on three-month deposits in China and Korea plummeted almost 1% over this week, driven by hasty withdrawals from money market funds and credit derivatives. The crisis has flowed from the States and is beginning to paralyze the whole global economy.


Korean and Chinese three-month yields have fallen from 4% to 1% in a matter of days. Asian investors appear to be opting for deposit accounts with government guarantees. Are investors now under the belief that Asian banks have yet to announce horrendous losses from the U.S. mortgage disaster?


The Hang Seng index in Hong Kong fell 4.15%, while Tokyo's Nikkei tumbled to the lowest level in a year and a half.


This sudden “flight from risk” has led to a sudden unwinding of the $1,200 billion Yen "carry trade" as hedge funds and Japanese investors close risky positions.

The Yen has roared back from Yen122 to Yen107.90 against the $ since early October, crushing the gains of those slowest to move out of these positions.


Then the capital Tsunami flowed back to Europe where:

The iTraxx index measuring default insurance on bank and insurance bonds hit an all-time high of 63.5. Bund-Swap-Spreads were going through the roof there. Spreads on low-grade European bonds had been jumping 10 basis points a day, for the last week.


Suddenly, in a startling move, the European Covered Bond Council said it was suspending trading of mortgage-linked bonds in the inter-bank-market owing to the "undue over-acceleration in the widening of spreads."


Abbey National today cancelled its sale of covered bonds, the third company to withdraw an issue this week.


Then there was an alarming spike in the "Ted spread" between commercial Libor and U.S. Treasury bills, now near 150 basis points. The London Interbank Offered Rate [Libor]] is now at a premium to T-bills not seen since the dark days of 1987.




And we are told to expect problems from this crisis could last for two more years as the real tragedy for the sub-prime mortgage holders. But now it is a $ / banking credibility problem threatening to engulf the entire global economy.

Authorities overseeing the crisis are blithely raising their hands saying markets must find their own level. This is complete inaction, but is it a result of their powerlessness in the face of these massive waves of capital?

The finger pointing at the suppressed Yuan is ducking the issue. The statement that the $ is not a problem of the U.S. is confirmation that the U.S. will not do anything about its weakness and why should the Fed? It is to their advantage to see a weaker $. We don’t expect the States to do anything about the weak $ now or in the future. From the perspective of the States, the $ is bedrock, so the problem lies with those dealing with the States. Not only is it in the interests of the U.S. to see a weak $, there is little that they can could do to rectify the $’s performance, until foreigners take action against it. But they are in a strong position to do so.

So the ball is in a foreign court. Until China and Asia are far less dependent on the U.S. it is not in their interest to see a $ collapse or even the buying power of the $ diminish. It is however in their interests to use the $ to buy up all the assets they can across the globe until they are spent. That would see a major rise in the power of China in the global economy. That is already well on the way and continuing at a frantic pace.

There is little incentive to sell the dollars to lower their presence in national reserves, because this would lower the value of the remaining dollars in the reserves. Consequently we all have to live with a falling $, consequential rising global inflation, picking up speed as the velocity of the fall of the $ is diminished through market intervention, breeding more inflation still. The result has to be paper currencies across the world having to accept that to keep their economies healthy they must accept inflation, or see their international competitiveness reduce their own national growth.



Gold - as a result

In such a climate there is absolutely nothing to stop the price of gold in all currencies from trending higher and higher and higher still.

The trigger to this rise is the awful loss of confidence in the banking system and the investments they have engineered. It is called “risk aversion”, but it is more serious than that. Harsh lessons are being learned from bitter experiences that have shocked even the most experienced of investors. Will the crisis go away we are told, not for some time to come? In fact, it could worsen as the structures on which confidence stands stumble under the doubts and fears.

Then it becomes simply a matter of prudence and wisdom for investors of all types in all parts of the globe to protect themselves against this turmoil in something that is not an obligation, a promise, something not dependent on the performance of people or any other hope. Where can they go? They need something they can know will not evaporate as quickly as a changing exchange rate, something they can grip in their hands, something solid that has proved itself in just these sort of times - gold.

With the global market so integrated, so informed, so fast and now so volatile, expect this relatively small market to get a great deal of attention to make it evolve into something totally different to what we see at the moment!

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Long Yuan = Long Gold?

http://www.kitco.com/ind/Coffin/nov142007.html

By David Coffin Printer Friendly VersionNov 14 2007 9:33AM

www.hardrockanalyst.com

It may sometimes seem that China is somehow both unaffected by andindifferent to the spiraling shifts of the world's currency andbanking sectors we are in. Neither is true. In spite of strong growthrates, China's economic re-emergence continues to be pinned to aseries of measured shifts by resilient party insiders to continuouslyrefine the "market communism" concept.

They appear almost ready toreap the rewards of a trade strengthened currency, and we believe thatwill signal further strength for gold. Without question the huge gains for gold and silver prices over thepast several months can be related to thrashing of the greenback. Thebreakdown of the US$ accelerated by bad housing debt is what we and,in increasing numbers, others have expected for several years.

The inverse relationship that helped push gold higher has been part of abroader relationship - Short Dollar = Long Commodities – in which goldhas actually been a laggard. Concern is growing that recent paraboliclooking moves for paper currencies and oil could mark the beginning ofa global downturn.

The concern is understandable, but we view it asunavoidable turbulence in the shift of economic weight across thePacific. Oil price gains chart both geopolitical concerns and the fallingDollar, but are well past any supply fundamentals. There is currentlyenough oil in the system to match demand, but since its suppliers areunhappy with their US$ contracts they have done little to sway thespeculators who have pushed prices higher. We have mused in the pastthat if the world needs a neutral commodity-based currency, it shouldbe the calorie. Traders are effectively making this happen by parking Dollars in long oil contracts.

This is hurting US consumption as muchas declining house values do. Further US dollar decline can beexpected, but oil can't continue to rise inversely to that declinewithout killing other US consumption and greatly denting Asian growth.Despite western consternation about Asian indifference to this, Chinaactually appears ready to deal with the issue.

Several influential Chinese have indicated they favour a rebalancingof its foreign exchange holdings to emphasize "balancing stronger andweaker" currencies. This may in part be aimed at trade sanctionproposals in Washington, but also we think at soaring oil prices.Markets have read this to mean Dollar dumping that will exacerbate theweakening of $/€ rates.

We actually think the impact on the Yen willbe as large (say sayonara, carry traders) as the push on the Euro,thought that is an aside for now. These musing bespeak the "controlledflexibility" that is becoming a hallmark of China's economicmanagement. China changed its foreign exchange policy several years ago from ahard Dollar peg to a basket of currencies in which the Yuan shifts value in a "managed float" band ("floating peg") that is 0.3% per daywide. The basket is "trade weighted".

An exchange of weaker forstronger currencies within its basket should mean that the Yuanappreciates more quickly. That would make it a more effective part ofthe floating exchange system, without China's governors having to giveup the "managed" part of the deal. A rising Yuan will also takepressure off the Dollar in due course, by making Dollar priced oil,and given the recent BHP-Rio Tinto merger "letter", also things likeiron ore cheaper per unit in the economy that is their one majorgrowth area. So, does that mean the gold run is over?

In the past decade China has made a strong move up the gold producerslist and is now generating more of the yellow metal than Canada orAustralia and getting set to take over number two spot from the USA.It does hold some gold in its Yuan basket. Adding to this by soakingup its domestic gold supply would allow China's central bankers to exchange Yuan for an anti-Dollar that has a liquid market, withoutraining on anyone else's parade. At $100 billion a year, gold'smarket may not easily become a significant part of the currencysystem, per se.

But China's current US$6+ billion a year of gold production would still help to offset the worrying decline in theDollar. Even if China's currency system is not about to become a significantgold buyer itself, a strengthening of the Yuan would add cost pressureto the yellow metal's output in the same way that rampaging Rand,Canadian$ and Australian$ rates have. In all cycles metal supplyshortages proceed rising metal prices, and these have always been feltlast in the gold sector.

The only difference in this prolonged secularbull cycle is that significant cost gains have been recognized by the market and become support for higher base metals prices. Goldproducers have not really gotten on top of cost gains yet, andfundamentals like this do, eventually, have their day.

A rising Yuan and China's increasing importance to the gold supply should combine underscore the lack of new gold supply, at current prices. Long Yuan will equal Long Gold.

David Coffin