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Monday February 7, 2005 - 11:16:37 GMT
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Dollar and gold hodgepodge


“The European Union is a success, measured by the continued desire of countries to joint it, and by the failure of any member so far to leave. But it is a muddle, chronically lacking a clear direction, for reasons that are likely to endure.”

Bill Emott, 20:21 Vision

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“The dollar's recent revival was given an extra push by Federal Reserve Chairman Alan Greenspan, who in a speech in London went to lengths to explain that after three years of declines, a weaker dollar will finally start having its intended effect of reducing the U.S. current-account deficit by chilling imports and boosting exports. He also gave a nod to the promise that new talk of fiscal responsibility and budget-deficit reduction also could help the current-account balance,” The Wall Street Journal reported this morning.

If it’s perceived the US is taking the deficit problem seriously, it will put teeth behind the “strong dollar policy” instead of just jawbone. This fits into our script—now several weeks old—that says the current account should no longer be the driving theme to rationalize dollar weakness. It’s quite possible that once the die hard dollar hatters and US “doom and gloom” crowd abandon their current account mantra, we could see another leg up in the buck. At some stage even die hard dollar bears will realize that the trend is a better friend than their ingrained beliefs.

Another leg up in the buck is a very plausible possibility here. Dollar bears had three good opportunities to see some of their concerns validated—it didn’t happen:

a) The Fed—no change in FOMC policy to “normalize” interest rates. The Fed Funds will continue to go higher.

b) Non-farm payrolls—yes, they came in a bit under expectation. But, it was still a “decent’ number and looked very good relative to the competition.

c) G-7—Finance ministers focused on poor country debt relief. There was only a passing mention of Chinese currency revaluation. China has again mad it perfectly clear that China will act when it best suits China.

Speaking of the G-7, you have probably seen reports indicating the finance ministers are seeking ways to pay for their good intentions on debt relief. The UK wants the IMF to tap its estimated $43 billion in gold reserves to pay the tab. Canada and other major gold producing countries oppose that option. But, accordingly, “the IMF is expected to present a list of options for paying for cancellation of its loans, including ways in which it could draw on its gold stock of 103.4 million ounces without roiling gold markets.” the Journal reported.

Last week, when Germany raised more than a few eyebrows with its dismal unemployment report, voices were raised by some in support of the Bundesbank unloading some of its gold stash in order to help the country raise a little cash for the unemployed.

Silly as it may seem to unload real assets i.e. gold, in order to fund bad debt and current consumption, we just might see it. Even if financial integrity prevails, and gold remains vaulted, the idea of gold sales is in the marketplace. It adds weight to some of the concerns weighing on the Comdols (C$ and A$), we think.

Two reasons why we don’t, and haven’t liked, the Canadian and Australian dollar lately:

1) Growing deflationary pressures, or falling inflationary expectations, will continue to pressure commodities: We think the long-bond yields are telling the story. We haven’t bought into the hard money crowd idea of runaway inflation based on central bank 24/7 money manufacturing (though we love the story). Why? Because it’s not happening! If you look at wheat, soybeans, corn and cotton you will notice prices heading down, way down. If inflation were for real, we doubt this dynamic would be playing out. The commodities doing well are primarily the industrial commodities and that seems predicated on China. Which leads to our second theme…

2) China has not yet landed—and it could be harder than expected: The consensus view is that China either has or will achieve a soft landing on the economic front. We’re not so sure about that. Massive investment is leading to overcapacity in some sectors and severe pricing pressure even in China. On the finished goods export side, this pricing pressure adds to global deflationary pressures. Then there is big time real estate speculation coupled with falling occupancy rates. And banks that have acted as state conduits to funnel money to China’s state owned enterprises to keep them afloat—these firms and banks could cascade down even if China only “slows.” Then we have China’s race to increase commodity supply everywhere—Central Asia, Middle East, Latin America… It seems we have the potential, or reality, of rising commodities supply in the midst of a potential major drop in demand.

Canada and Australia have benefited much from Chinese commodity demand. And will continue to benefit many years into the future from that demand. But, there could be some near-term turbulence. If so, it could push the Comdols and most people’s favorite metal much lower from here.

Here is a chart gold, C$, and A$ for your review. All have come a long way in the last two years. A standard correction (show as 0.382 and 0.500 lines on the chart) would look very ugly from here…

Jack Crooks.


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