Gold, Silver, Metal Prices: Commentary (10/12/2009)

Dollar: The Reports of My Demise…

Good Day,

Although some gains were seen in the dollar versus the euro and the pound earlier this morning, a hefty $1.78 addition to crude oil values helped keep gold’s flywheel-like momentum going for yet another day.

The yellow metal traded in a $10 band of from $1048 to $1058 and managed to recover most of Friday’s $6 loss at several points during the overnight and early morning session in NY. Markets are noticeably thinner as some have taken the Columbus Day holiday (and Canadian Thanksgiving) off. As well, with the world of (base) metals congregating in London, there are numerous bodies absent from various desks around the world.

At that very event, we have heard of calls to craft global arrangements that would regulate the wild and woolly niche of commodities. Lest of course, one enjoys the type of government-flavoured knuckle-rapping that follows spectacles such as last year’s oil ‘rally.’ Bloomberg reports that:

"A global agreement to regulate financial markets including commodities is needed to keep investors from moving business to "less regulated or unregulated markets," according to CPM Group Managing Director Jeffrey Christian.

President Barack Obama’s administration has sought tighter oversight of derivatives, contracts used to hedge against risks such as swings in stocks, currencies, commodities and interest rates. The European Union in July called for the use of clearinghouses for some over-the-counter derivative trades.

Clearing, reporting by private equity funds and "transparency" need to be considered, Christian said at a London Metal Exchange conference in the British capital today, according to an e-mailed copy of his presentation. "Piecemeal regulation at the national level will leave the markets vulnerable to shifts in trading from regulated markets to less regulated or unregulated markets." Governments are trying to cut risk in the $592 trillion over-the-counter derivatives markets after the collapse of banks such as Lehman Brothers Holdings Inc. "

A quick check of the latest in New York spot prices showed gold at $1053.50 with a $4.60 per ounce gain, silver at $17.84, adding 14 cents per ounce, and platinum up by $2 at $1335.00 per ounce. Palladium rose $5 to $323 per troy ounce. Gold’s gains were evenly split between dollar weakness ($2.10) and actual buying ($2.50) as shown by the KGX Kitco Gold Index found at http://www.kitco.com/kitco-gold-index.html. The greenback was last seen at 76.20 on the trade-weighted index.

So, what really happened last week? For an interesting but true take on matters, we consulted a source with the ultimate bullishness of which we normally do not see eye-to-eye. However, the relevant observations made by yet another person who has spent decades in the trenches of this battle, are very much worth your attention. Ned Schmidt’s words over the weekend echo those of NY and London traders we normally hear from on a daily basis to the finest of details. Here is what they read like when referring to last week’s golden chariot race:

"A false rumor, encouraged and spread by some less than knowledgeable writers, of the oil nations turning away from the dollar was the catalyst for the stampede this past week into Gold. That rumor was later decisively quashed by Reuters.

But, facts did not matter, for the institutions were turning to Gold simply because the returns were too good to be ignored anymore. If they were going to continue extracting unjustifiable fees from gullible clients, Gold had to be included in portfolios.

$Gold has clearly moved into Wave V of an Elliot Wave framework. That wave is characterized by money chasing price action. Buying is being done out of a belief that the price will move higher. In short, pure greed, emotion rather than logic, is in control. That is what happened in the Gold market this week. People were buying Gold simply because of a belief that it would go higher. Facts to support those beliefs were generated afterwards.

The growing fervor of that emotionally charged buying can be observed by the mini parabolic curve that has developed. It has been marked in the top graph on the previous page. But, while emotions may have been in control, we admit to enjoying it. Though, we must note, all parabolic curves are converted into disappointment. The bearishness on the U.S. dollar is reaching an extreme. In this coming week’s Gold Thoughts we will review Federal Reserve actions, not their words. Federal Reserve policy, for all the talk and smoke, is effectively tightening at this time. That suggests both dollar strength and a weakening U.S. economy ahead.

We do need to note, though, that the funds being provided to the U.S. financial system by Federal Reserve are flowing directly into financial markets. The preeminent reason that paper equity markets, Gold, Silver, and oil moved higher this week was margin buying by funds and other investors. These markets are at this time in minibubble status, and disappointment will reappear. The U.S. dollar is deeply over sold, and has been so for some time. Such a development should be a prelude to, at a minimum, a technical bounce in the value for the dollar. That view is clearly not aligned with the consensus. The panic buyers of Gold this week may come to be disappointed that immediate gratification does not occur."

Gratification of that type has thus far been offered only by the ever-slipping US dollar. But, how much substance is there behind the incessant dollar-death talk? How much of it is speculative fervor versus a foundational, logic-driven rearrangement of the decks? And, it is all bad? Since many of you are going to go into slow digest mode this afternoon, we thought we would bring you something more meaty to digest than is normally the case. A lengthy expose on the dollar’s woes and future possibilities. To say that is smells and feels just like 1995 when dollar bearishness went off the charts only to be followed by a 26% rebound in the currency, would be to state the very obvious. Thus, it is time for more food. For thought. CNN Money chimes in and finds that:

"It sounds like the plot of a bad spy novel. A group of international villains are holding a secret meeting in their headquarters — which are naturally buried deep in the side of a mountain. They are thinking of grand schemes to destroy the American dollar and replace it as the global standard with a basket of other currencies and gold. All we need is to have the group’s leader stroking the pet cat sitting on his lap to make the scene complete. Mwa ha ha ha ha! Now they say that the truth is stranger than fiction. But the notion that a group of oil-rich Middle Eastern nations, Russia, Brazil, France, Japan, India and China are actively looking to replace the dollar as the currency of choice for pricing oil in the not-so-distant future seems a bit silly at this point.

Yes, the dollar has weakened significantly in the past few months. And that has to be a cause for concern for oil exporters as well as nations that hold big chunks of other dollar-denominated assets such as U.S. Treasury debt. But it doesn’t appear as if the dollar is on death’s doorstep just yet, despite what was reported in a very sensationalistic article in the British publication The Independent earlier this week. The fact that U.S. Treasurys have rallied sharply in recent weeks is one sign that some of the concerns about the dollar are overblown. If people were so spooked about the possibility of skyrocketing 1970s style inflation, it’s hard to fathom why anyone would be buying long-term bonds right now.

Yet, the yield on the benchmark 10-year Treasury is currently hovering around a relatively low 3.3%, down from nearly 3.9% two months ago. Bond prices and yields move in opposite directions and lower yields are usually a sign that bond investors aren’t too worried about inflation. With that in mind, Michael Strauss, chief economist with Commonfund, a money management firm based in Wilton, Conn., said he thinks that the recent surge in other inflation hedges such as gold and oil are more about speculation than anything else.

"There is a disconnect here. You look at gold and oil. Gold has no industrial purpose so it’s not about supply and demand. Oil’s run-up doesn’t fit with what the price of gas and other byproducts are doing," he said. "So if people are really worried about inflation, why is the yield on the 10-year this low?" Keith Hembre, chief economist with First American Funds in Minneapolis, added that the recent surge in stocks also wouldn’t be justified if the dollar was really headed towards obsolescence. Sure, there is some element of people trading out of the dollar and into other riskier assets like stocks because there is a growing belief that the global economy is recovering. But Hembre argued that if people really feared that the dollar was expected to weaken much further, then there would be little reason to make bets on any U.S. companies or government debt..

"If there was a true dollar crisis, you’d also have a flight from dollar denominated assets," he said That mean would Treasury yields would be higher and U.S. stocks would be a lot lower." And for all the talk of how weak the dollar is right now, it’s not as if it’s at all-time lows just yet. As the narrator on the canceled way too soon ABC show "Pushing Daises" would say, the facts are these. The dollar is trading at about $1.47 against the euro. That’s a 17% slide since the stock market rally began in March, but the dollar was 8% weaker at last year, at about $1.60 to the euro — an all-time low. The dollar is also still about 7% above the low it hit in March 2008 against a basket of six other global currencies.

Of course, the trend lately is for the dollar to go down and that trend bears watching. Nobody wants to see the greenback come close to last year’s levels, especially since that round of dollar selling also coincided with record high oil and gas prices. But there are also some benefits to a weaker dollar. It helps make U.S.-made goods cheaper, which could provide a boost to demand for American exports. "Looking forward, if consumer spending is not leading the U.S. economy, one way to finance growth is through a weaker dollar. In the context of an expanding global economy, the weaker dollar is positive for U.S. exports," Hembre said. Big U.S. corporations also could get a lift to their profits because international sales will be higher when translated from stronger currencies like the euro back into dollars.

A cynic could rightfully point out however that it’s not certain that the global economy is recovering but not yet recovered. So it may be a mistake to expect that consumers in Europe and emerging markets like China, India and Brazil are going to lead the United States out of its funk by buying tons of cheap American cars. What’s more, the currency translation bump to earnings is more of an accounting trick than anything else. It is going to be more critical for companies to report sales and earnings growth because of real demand, not favorable foreign exchange rates. Still, there may be a floor to how low the dollar falls. Economists said the talk about replacing the dollar is probably due more from a desire to pump the dollar back up than a real wish to get rid of it as the reserve currency.

"The reason the dollar isn’t dead yet is that you haven’t seen a major fundamental change in many of the economies of the countries that are worried about a weak dollar and favor a strong dollar. They want their own exports to be cheap," said David Merkel, chief economist with Finacorp Securities, a broker-dealer based in Irvine, Calif. "We could get back toward record lows on the dollar, but it would only be after a failure to intervene by central banks that are interested in keeping the dollar strong," he added.

There’s also the issue of what a much weaker dollar would do to the investments that many countries have in U.S. dollar-denominated assets. China, for example, is the world’s largest owner of Treasurys, with more than $800 billion worth of bonds. "The dollar weakness may be putting pressure on China," Commonfund’s Strauss said. But other than trying to act tough, Merkel thinks there is not much China or other nations can do if they are unsatisfied with the dollar’s decline. Merkel said that selling bonds to minimize damage from further hits to the dollar is not an option just yet because selling Treasurys would just lead to a further erosion in value of existing holdings.

"If you are taking on too much dollar debt and you don’t like it, then you have to take the pain. There may come a day when countries are willing to do so but they are not ready this go around," he said. Hembre agrees. And he doesn’t believe that there’s much that will be done other than to let the currency markets run their course. The Federal Reserve could try and prop up the dollar in order to quell long-term inflation fears sparked by concerns about the glut of money pumped into the economy in the form of stimulus and bailout packages.

But it appears that the Fed is going to keep rates near zero for some time in order to make sure the recession (which some believe is over) doesn’t get worse. Hembre thinks that is the right move because the risks associated with a weak dollar are far outweighed by broader concerns about rising unemployment and what appears to be a still fragile recovery in the housing market. "The dollar is simply not an issue. Dollar weakness would only become problematic if it caused disruption in funding markets which led businesses or governments to be unable to finance their spending needs. We see no evidence of that," he said. So it looks like all those nefarious plots to take down the dollar may not be coming to pass after all."

Enjoy you holiday and be thankful for the bounty.

Jon Nadler
Senior Analyst

Kitco Metals Inc.
North America

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