October 10, 2009

Market Insights - 10 October 2009

Dear Friends & Fellow Investors

Here is our new issue of market insights.
In case of questions, please email: .  Enjoy reading!

In This Week's Issue
▪   Weekly Snapshot
▪   Chart Of The Week
▪   US Dollar Unplugged
▪   Time Has Come? 
▪   A Hat-Trick For Gold 
▪   The Magic Triangle 
▪   Signposts

Weekly Snapshot
• US trade deficit declined by 3.6% to $30.7 billion in August (AP)
• Asian central banks intervene to slow the decline of the US Dollar (FT)
• US retailers in first monthly sales gain since Sept-2008 (FT)
• Bank Santander of Spain raises $7bn in Brazilian IPO (FT)
• Bank of England kept their benchmark interest rates at 0.5% (Bloomberg)
• The ECB kept rates unchanged at a record low of 1% on Thursday (Reuters)
• US jobless claims fell by 33,000 to a 521,000 lowest in 9 months (Bloomberg)
• Euro area GDP down by 0.2% and EU27 GDP down by 0.3% (Eurostat)
• Spot Gold reached a new all-time highs on Tuesday, Wednesday and Thursday (eSignal)
• The Australian and New Zealand dollars climbed to their highest levels in 14 months (Bloomberg)
• Australia's Central Bank unexpectedly raised rates to 3.25% and signaled further increases (Bloomberg)
• Australian Stocks at highest level in 12 months (eSignal)

Chart Of The Week 
Gold broke all records this week and reached a new high of $1,061.50 on Thursday before closing the week just under $1,050.   Much of the gold strength was related to the Dollar weakness.  More on Gold below...


Source: http://www.stockcharts.com 

US Dollar Unplugged 
Plenty of newsworthy developments with regard to currencies this week.  You may have heard about “secret meetings”  by some nations to consider the end of US$ dealings for oil.  Robert Fisk of the Independent outlines various scenarios in his recent article: The demise of the dollar.

In direct opposition to these findings, Mike Shedlock gives a rather different perspective in his post: Ridiculous Hype Over Secret Oil Meetings. 

I would like to share his “Ten Simple Facts” as to why he considers this a non-issue:

1) Oil is priced in dollars.
2) Oil trades in Dollars and Euros right now in spite of the pricing unit being dollars. OPEC has recently admitted this fact.
3) Clearly oil does not have to be priced in Euros to trade in Euros, or for that matter priced in Yen to trade in Yen. The same applies to any major currency.
4) Neither Venezuela or Iran hold any dollar reserves. To the extent that either is taking trades in dollars, there is clearly nothing forcing them to hold dollars. By extension there is nothing forcing any OPEC country to hold dollars if it doesn't want to.
5) It takes less than a second for Forex trades to take place. 24 hours a day, 7 days a week, one can sell any currency they want and buy any other currency.
6) The above logic applies to any currency and any commodity.
7) Nothing is stopping anyone at any time anywhere from selling dollars for whatever currency they want to hold. Nor is anything stopping anyone anywhere at any time from selling any major currency for U.S. Dollars.
8) Because currency conversion is instantaneous no one has to hold U.S. dollars to buy oil, copper, gold, iron, lead, wheat, soybeans, or anything else.
9) Dollars are held (or not held) for reasons totally unrelated to pricing unit. Some of those reasons are political, some are based on sentiment, some on trade patterns and trade relationships, and some to suppress the value of local currencies to improve exports.
10) Currencies float and so do the price of oil and commodities. Pricing oil (or any other commodity) in Euros will not cause a price change in dollars. Look at gold which is simultaneously priced in everything as proof.

The news about these secret meetings, first reported by the Independent, sparked somewhat of US Dollar sell-off earlier this week.  Yet, there are more significant factors influencing the possible demise of the US Dollar.  However, we should not discount the huge psychological impact on a change in pricing policy for one of the most sought after global commodities.  A departure from pricing oil in US Dollars is yet another sign of the changes in global economic powers and an indication of the “new normal”.   

While Mike Shedlock makes some valid points, the realities of managing a commodity and its pricing unit compared with the holdings of Dollars or another currency are NOT totally unrelated.  Anyone having done a series of trades in different currencies and different commodities can attest to the fact that there are certain correlations at play.  Views on exchange rates need to be re-assessed on the basis of long-term planning and the expectations of future price increases in the commodity are very much having an  impact on the currency holdings of an exporter or seller of that commodity.   If there was no impact, why would these nations even consider a pricing unit other than the US Dollar?  It is obvious that many of these nations, particularly those with vast holdings of US Dollars, fear a decrease in the value of the Dollar and by considering a reference price of their goods in another currency or within a basked of currencies, they wish to achieve some price stability.

On a slightly lesser note, currencies can indeed be traded 24 hours a day and many countries allow holdings of foreign currencies within their banks (Ed. Note: Did you ever wonder why no bank in the US offers foreign currency savings or multi-currency accounts?) but there is also a cost associated with changing currencies on a regular basis.  Historically, all OPEC nations from the Gulf have pegged their currencies to the US$.  As recipients of vast amounts of Petro-Dollars this not only made practical sense, it also guaranteed a relatively stable domestic economy on the basis of piggy-backing onto the growth and the stability of the world’s most powerful economy.  That concept has worked fairly well over decades until recently when some Gulf nations started to open up their currency peg and included other currencies, namely the Euro as a reference currency.  It remains to be seen how soon the Gulf nations can wean themselves from the Dollar.  The mere fact that these discussions occur more frequently these days is a sign of things to come...

Time Has Come?
The Australian central bank raised interest rates by a quarter point on Tuesday.  Australia is the first G20 nation to tighten monetary policy this year and this could be a significant turning point in the aftermath of the global financial crisis.   Markets were taken by surprise and it triggered some questions as to which countries would follow suit in starting their rate tightening cycle.   Australia, being a commodity rich country may be a special case, having avoided a massive recession and enjoying a comparatively robust banking system. It does however highlight the views of some optimists that the worst is over and that time has come for new period with higher rates.  See the benchmark rates for that major currencies below and consider that a significant factor for the recent strength of Australian and New Zealand Dollars is the interest rate differential.  With no sign of a change in US monetary policy, this rate differential continues to encourage carry-trades.

Central Bank Rates
AUD 3.25%   NZD 2.50%   EUR 1.00%  GBP 0.50% 
USD 0.25%    CAD 0.25%  CHF 0.25%   JPY 0.10%

A Hat-Trick For Gold 
Gold prices reached a new all-time high of $1,061.50 achieving a hat-trick of three consecutive new all-time records this week.

Can Gold maintain its current trajectory and reach levels of $1500 and above as some analysts predicted? Or will we see some profit taking of the smart players now while the herd may jump in too late?  As a reference point, compare Gold with Copper.  Even more volatile than its more precious cousin, Copper has doubled in price since the beginning of the year and has outperformed Gold five-fold.


It remains to be seen whether commodity prices will reach higher levels yet but volatility in these markets is unlikely to disappear anytime soon.  As for Gold, anytime a tradable asset reaches a new high or a new low the crowd mentality kicks in sparking yet more demand and supply for a perhaps already over- or undervalued asset.  This can drive price-trends in the same direction for a while longer.  However, one needs to step back and carefully consider if the rationale for buying the asset still holds true at even higher prices. 

Meanwhile the list of Gold supporters goes on. The always outspoken Peter Schiff, never shy about making controversial predictions, recently predicted Gold might hit $5,000 per ounce.

Perhaps less far-fetched was a commentary by Jim Rogers that Gold will hit $2,000 an ounce within decade
That seems reasonable;  assuming no major changes from current economic conditions and imputing an average annual inflation rate of say 4%, a Gold price of $1,000 today should be valued at $1,480 within a decade.  If one were to take the view of some inflation hawks that inflation could average over 7% per year, we have then arrived at the $2,000 Gold price within 10 years.  Although the inflation record of Gold is somewhat controversial $2,000 an ounce is not nearly as far fetched considering that the inflation adjusted all-time high of Gold in 1980 is over $2,000.

The Magic Triangle 
How vivid is your memory in terms of your first encounter with percentages?  We use percentages on a daily basis and yet, the magic of this mathematical concept can sometimes elude us.

Did you know that –58 + 61  =  -32?   That is the result of figuring out the returns in equities since the peak of the major benchmark index in late 2007.  Just a reminder of where we stand.


As the Financial Times reported this week, Spain’s Bank Santander completed a share offering for its Brazilian banking unit that raised $8 billion. This is the world’s biggest IPO so far this year and not the first time that institutions are looking towards developing and natural resource-rich countries to raise capital.  This trend is likely to continue and traditional creditor nations for developing countries are increasingly becoming debtors of countries like Brazil.  It also raises the question:  Will countries like Brazil continue to make loans in US$ or will they insist on financing in their own, increasingly stronger currency?  At this time, the largest debtor nation can still call the shots, demanding capital on their terms (at historically low rates)  and in their own currency (US$).  But how much longer?

Good luck & good trading!

Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this communication be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance.

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