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US Dollar to Remain Oversold

Here’s what we said about the immediate future last Friday, in our weekly update to Australian Wealth Gameplan readers:
At the risk of making a foolish prediction I will do so anyway: the [U.S.} dollar will remain oversold as the Aussie reaches parity and gold goes over $1,400. But doubts about the Fed’s ability to do anything about America’s economy and the mushrooming mortgage foreclosure scandal are nipping at this market’s heels. Having broken those key psychological barriers, the big reversal/correction will come.

Mind you it’s incredibly strange that screaming red indicators of serious weakness in America’s financial system should be, of all things, [U.S.] dollar bullish. But the important point to remember is that the “risk trade” that has powered Aussie shares and commodities higher will be off the boil on renewed worries about the health of the U.S. financial system. The world will suddenly appear a lot riskier to traders and that should lead them pull in their head a bit on commodity prices (which are already looking toppy).

This doesn’t mean I’m a long-term dollar bull (far from it). But look for a reversal soon, probably next week. And then, the next phase…the actual quantitative easing from the Fed and the escalation of the mortgage foreclosure crisis.

This latter event threatens to blow an iceberg sized-hole in the hull of the American financial system, requiring another Federal bailout of trillions of dollars that America doesn’t have. This will be the death blow not just for the dollar standard but for the Bretton Woods two system of floating exchange rates. Gold will move up against all paper in that world. And it’s coming sooner than you might think.
–Based on that prediction, we’re still in the first phase of effects, where the “risk trade” reverses and stock and commodity prices fall, along with the Aussie dollar. Our guess is that faster and further the market falls, the easier it is for the Fed to make the case for Quantitative Easing. There will be a lot less resistance after another mini-crisis/market fall. It’s a clever tactic.

–You can allay the fear that Quantitative Easing II is hyperinflationary by engineering a crisis in which investors lose a few hundred billion dollars in a matter of days. A 10% correction in stocks and commodities puts the market at a lower base from which QE II can begin. It also neutralises the price signals commodities are otherwise screaming to prudent investors (inflation dead ahead!).

–But maybe we are being a bit too conspiratorial about everything. The banking cartel that runs America’s money would never manipulate the market like that, would it?

–Embedded in our analysis is that the recent strength of the Aussie dollar is only relative. That is, the local currency has become the plaything of the moment for U.S. dollar bears seeking yield. When the dollar bears take profits, the short-term gains in the Aussie will reverse too, even if the RBA raises rates on Melbourne Cup Day. This is probably bullish for the Australian price of a certain yellow metal that lives at number 79 on the periodic table of elements.

–But don’t forget number 47 either! That’s silver. According to another Bloomberg story, “Silver exports from China, the world’s largest, may drop about 40 percent this year as domestic demand from industry and investors climbs, according to Beijing Antaike Information Development Co.”

–“Customs data show exports plunged almost 60 percent to 970 tons in the first eight months. Cancellation of an export rebate in 2008 is also hurting shipments…Reduced exports may bolster prices that are trading near a 30-year high on speculation that governments worldwide will take further steps to stimulate their economies, weakening currencies and increasing demand for assets that are a store of value. China, the third-largest producer after Peru and Mexico, revoked export rebates in August 2008 to curb use of natural resources.”

–China taketh away credit…and silver and rare earth exports. That’s a whole lot of hoarding going on. Of course, China can’t “put back” nasty American Treasury debt to the U.S. Treasury the way investors can “put back” mortgage debt to banks. It appears to be doing the next best thing, buying and accumulating real metals of real value.

Courtesy Daily Reckoning Australia

Maybe central bankers are buying gold because their respective finance ministers are actively trashing local cash. “We’re in the midst of an international currency war, a general weakening of currency,” says Brazil’s Finance Minister Guido Mantega in today’s Financial Times. Exporting nations are trying to boost competitiveness by keeping their currencies cheap and the price of their exports low.

It’s a strange old world when you improve your economic strength by weakening your currency. Japan and other Asian exporters (dependant on credit-financed consumption in North America) have been doing it for years. But maybe not everyone got the memo from the stock market in 2008 than the global credit bubble has popped.

You have to wonder if the strong Aussie dollar will hurt the competitiveness of Aussie exporters. It will probably hurt some a lot more than others. By “others” we mean commodity exporters. For now, any rebound in global mining investment has not led to a huge new production increases in the key commodities produced by Australia (iron ore and coal). The strong dollar isn’t hurting a bit.

But Chris Richardson from Access Economics warns us not to take the high terms of trade and commodity boom for granted. “Australia’s fiscal finances, both short and long term, are hostage to the fate of commodity prices, and hence to China’s strength,'” he recently wrote. He added that Australia’s Federal budget depends on high commodity prices to end the deficit.

–“The return to surplus trumpeted in the official forecasts is a pure punt that China and India will keep growing faster than the world’s miners will keep digging deeper,” Richardson says. “The budget used to be stodgy and boring and responding to a whole range of economic indicators. Now its health or otherwise is very narrowly based on coal or iron ore prices, and that’s a very fickle thing to rely on for fiscal health.”

From Dan Denning in St Kilda for the Daily Reckoning Australia

Aussie Dollar hovers near five month high

The Australian dollar was little changed near a five-month high after a quiet day of trade having kept most of the gains made in the past 24 hours.

At the close of local trade, the dollar was buying 93.28 US cents, up from Monday’s close of 93.20 cents. It reached 93.62 cents overnight, the highest since April 15.

CMC Markets foreign exchange dealer Tim Waterer said there was little impetus for the local unit to push higher during the trading day.

‘‘It’s kept in a fairly tight range, but it held onto its overnight highs.’’

The local dollar rose 1 US cent during Monday’s trading day on the back of official Chinese data showing consumer prices rose 3.5 per cent on year in August, compared with 3.3 per cent the previous month. It was the fastest pace since October 2008 – the height of the global financial crisis when consumer prices rose four per cent – and above the government’s annual target of 3 per cent.

But the unit’s rise wasn’t to be repeated during Tuesday’s domestic session, despite the publication of an upbeat private sector business survey.

Business confidence rebounded to levels last seen in April as profits improved although sales and employment conditions weakened, the National Australia Bank business confidence survey showed.

The data also showed business conditions were unchanged at an index reading of 5 points in August.

NAB said employment conditions were at the lowest level this year, although still in positive territory, with the index falling to 3 from seven the month before.

Mr Waterer said there was potential for the unit to trend higher on Tuesday night with the release of US Advanced Retail Sales by the US Census Bureau. Investors have been waiting for the data since Monday, Mr waterer said.

The median market forecast is for sales to have risen 0.3 per cent in the month.‘‘If its a good number, the Aussie might move higher,’’ he said. ‘‘If its lower (than the forecast), it could give the market some room for profit taking.’’

The RBA’s trade weighted index (TWI) was at 71.4, up from Monday’s close of 71.3.

Great Performance By Gold

From Dan Denning in St. Kilda:

–How about another big hand for gold ladies and gentleman? What a great performance by the yellow metal. The near-month futures contract for element number 79 on the periodic table traded at an all-time high in New York. Gold’s new benchmark, for now, $1,257.30.

–Of course that’s the picture in U.S. dollar terms. In Aussie dollar terms, gold is up 9.8%. In the last six months, it’s up 19.58%. Over the last year-taking into account the slump from its all-time highs in May-it’s up just 2.18%. And over five years, it’s up 147%.

–You can see that Aussie gold has some work to do before it makes new highs like the USD counterpart. A weaker Aussie dollar would do the trick. And who knows?

–Maybe another twelve months of political uncertainty and a renewed debate about a mining tax will weaken the local unit. Of course it’s also possible that the prospect of a weak government with a small majority is bullish for the dollar inasmuch as that government won’t be able to do much. We’ll see.

–In the meantime, all the real double- and triple-digit action in the gold market is in the equities. This is where you get the most leverage to the gold price. But we have to admit, we’re a bit ambivalent about it. This moves you into the realm of speculating more than buying an undervalued asset that’s due for a mean reversion.

–Below, you’ll find a note from our old desk mate in London, Adrian Ash. He does a good job of looking at the merger and acquisition activity in the gold market. Ade points out that for big gold producers to gain more exposure to the rising gold price, the quickest way is through acquisition. New discoveries of major gold deposits aren’t keeping up with demand, and, in fact, have fallen steadily since 1980.

–You could argue, of course, that even if the supply side for gold looks pretty bullish, the demand side could quickly change. What would make that happen? We’re tackling the scenarios in more depth in an early edition of the next issue of our newsletter Australian Wealth Gameplan. But without elaborating, the things that could lead to lower gold demand are: liquidation by major investors in the gold exchange traded funds, a resolution to the mortgage rot in America’s financial system that investors actually believe and allows houses to reach a clearing price without major social fallout, or the banning of gold ownership by the public and the fixing of its price (although this would, in fact, mean higher gold prices).

–But it’s really the first issue – the investment demand for gold – that probably holds the key to its run from here. Our fundamental argument is that owing the collapse of the Welfare State funding model (perpetual debt serviced by higher taxes) gold is being remonetised into the global financial system. It’s not just a commodity.

–As a practical matter, though, that’s probably not what most investors think when they buy gold shares or a gold ETF. That’s okay, too, though. What it means, we reckon, is that gold is finding a place (albeit very small) in the asset allocation/diversification strategies of investors. This hasn’t really happened before, except on the lunatic fringe where we hang out. A minor shift in preferences away from equities and bonds and toward precious metals (real money) is enough to support considerable gold demand.

–That’s probably a claim we should quantify and prove. And we will. But we’ll do it on our full research report for paid subscribers first and report back to you later.

–What makes us nervous about gold stocks – especially Australian ones, but in a good way – is that you can never quite tell what’s going on in the trading action. It’s true that an inherently irresponsible monetary and fiscal policy globally makes gold stocks very attractive because of the leverage to the gold price.

Courtesy The Daily Reckoning Australia

Having read through US Federal Reserve chairman Ben Bernanke’s speech at Jackson Hole, Wyoming over the weekend we can only come to two conclusions. Either Mr. Bernanke is stark raving mad and should be sent to a nut farm immediately. Or, he should be carted off to The Hague to face charges of crimes against humanity.

“Governments and central banks must do more.” He says.  Unfortunately, the doing more involves pushing the US economy further down the drain and leading to the impoverishment of even more people. But the really frightening thing is the admission that the Fed has no real idea what impact their policies will have on the economy

As Bernanke points out: “One risk of further balance sheet expansion arises from the fact that, lacking much experience with this option, we do not have very precise knowledge of the quantitative effect of changes in our holdings on financial conditions.” Bernanke is referring to the Fed’s decision to reinvest proceeds from maturing mortgage backed securities into longer dated Treasury securities. However, not knowing what the consequences will be doesn’t mean the Fed is about to stop what it’s doing. That’s because even though the Fed doesn’t know the consequences to the wider economy it does know the consequences to the banking sector should it pull the pin on its zero interest rate monetary policy. Bernanke, perhaps unintentionally, gives the game away when he said: “Also, in such a situation, higher inflation for a time, by compensating for the prior period of deflation, could help return the price level to what was expected by people who signed long-term contracts, such as debt contracts, before the deflation began.”

Yes, that’s right, deflation isn’t so crash hot for bankers because it makes servicing loans that much more difficult. If prices fall – a good thing – then it could lead to a fall in wages – not necessarily a bad thing if prices have fallen – which would naturally make it harder to repay a loan where the repayments are now higher in real terms. In other words, your debt repayments are the same, but your wages are lower. Hence Bernanke using the example of “debt contracts” to highlight the supposed perils of deflation. It’s funny how the only example Bernanke could come up with to fear deflation is the impact on debt contracts. But that’s probably because it is the only negative of deflation – negative for the banks that is. And if Bernanke and his posse at the Fed are worried about deflation and the impact on their chums in the banking sector we can guarantee that Glenn Stevens and his “peeps” at the Reserve Bank of Australia are even more worried about deflation and banking – as I’ll illustrate shortly.

But as we’ve pointed out before, deflation isn’t the bad guy. It’s the good guy. Inflation is the bad guy. Monetary and price inflation is what makes you poorer. It’s what makes you have to work harder. Inflation discourages savings and encourages spending and borrowing. Inflation means you have to work harder and longer. Whereas deflation should mean you can afford to retire early as the savings you’ve built up in your younger years increase in value as your cost of living decreases as you get older. Furthermore, because your savings are increasing there’s no need for you to take excessive risks by investing in the stock market or in property. You can just keep the money in the bank… or even under the mattress and it won’t lose purchasing power. In fact it will gain purchasing power. That’s how it should work anyway.

Of course you can be sure that even in countries with deflation, the crackpot government will still try it’s hardest to find some way of even stuffing that idea up. Anyway, you see, not only does deflation mean bad news for the banks in terms of existing loan contracts, but also, deflation means bad news for the banks in terms of potential loan contracts. Put it this way, imagine that you’ve saved up a bunch of cash in the bank. It doesn’t matter how much, but there’s something you really want to buy – a house, a car, a new television… In an inflationary environment there’s the pressure to buy now before prices go up – you’ve heard that one before! You’re worried that if you hold out any longer the thing you’re after will be more expensive.

So, what do you do? You take out a mortgage, a car loan or a personal loan to buy it now. That means, over the lifetime of the loan you end up paying a lot more than if you’d paid in cash for it at the time, or most likely if you’d just waited until you had the cash. But in a deflationary environment where prices are gradually falling towards the equilibrium price then the savings in your bank account (or under your mattress) are appreciating in real terms – even if you don’t earn any interest. Therefore, you’d be more inclined to wait before you made the purchase. Or if you’re really lucky, prices could be falling so quickly that you don’t have to wait. Let’s just look at a couple of examples of price inflation in action. Take a look at the numbers and consider which you think makes you better off. First up, below is a table from a paper prepared by the Bank of International Settlements (BIS): Healthy and unhealthy balance sheets Source: BIS It shows the relative household balance sheets for Japan, United States, France and Germany combined, and the United Kingdom.

As you can see, not surprisingly, banking deposits account for 51% of all Japanese household savings, but only 16% of US household savings. Why? Look, I won’t claim to be an expert on Japan. There are plenty of people out there who lay claim to that. And we won’t make any sweeping generalisations about the Japanese culture either. But according to the authors of the paper – Shinobu Nakagawa and Yosuke Yasui: “Several reasons could apply, among them (1) a representative Japanese household needs a significant down payment to purchase a house and thus would like to avoid investing in risky financial assets such as stocks, (2) most elderly people, who hold a majority of retail deposits in Japan, were educated to believe – and still believe, to some extent – that saving (such as through bank deposits) is a virtue and that the indirect finance system works, and (3) there has been no rational reason to invest in risky assets in the deflationary or disinflationary environment that has enveloped the Japanese economy for many years.” See? You don’t need to invest in risky assets like shares or housing when price inflation is non-existent. Another reason of course is that there’s less need for households to go heavily into debt.

Take a look at the Japanese Consumer Price Index (CPI) for the period 1994 to 2009.

I don’t have enough space to paste the whole table here, but here’s some of the highlights… The general CPI in 1994 was 100.8, today it’s 100.3. Food in 1994 was 102.3, in 2009 it was 103.6. In 1994 housing was 94.9 and in 2009 it was 99.8. How about fuel, light and water? In 1994 it was 97.2, and 106.1 in 2009. Clothing was 102.9 in 1994 and just 101.0 in 2009. And get this, Furniture and household utensils was 130.5 in 1994, but only 93.9 in 2009. In other words, the cost of living across most categories is flat or down – what the mainstream economists would call deflation – over a fifteen year period. It means that Japanese households don’t need to go so heavily into debt in order to fund everyday purchases or even big ticket items. Now, explain to me again how price deflation is bad for you? It needs some explaining, because to be honest we’re puzzled how falling prices of something like furniture and household utensils could be bad for any consumer. I mean, who doesn’t want to pay a cheaper price for a spoon? But how do we compare in Australia? A country that isn’t as “moribund” as Japan supposedly is. A country that’s supposedly much better off because we haven’t “suffered” the deflationary peril that Japan has. In the March quarter of 1994 the Consumer Price Index (CPI) in Australia stood at 110.4. By the end of 2009 it was… 169.5. Take a look at that number again… 169.5. Once more… 169.5. In other words, an approximate 50% increase in the price of goods when during the same period Japanese households suffered the ravages of deflation that caused a… [ahem] 0.4% drop in prices! Does the massive increase in price inflation in Australia mean that Australians are vastly wealthier or better off than Japanese households? I don’t know. As I said, we aren’t about to make a sweeping statement about Japan considering our one and only visit there was a 14 hour stopover on a flight to the UK about thirteen years ago (Australia to the UK via Japan was the cheapest flight available at the time!) But what we do know is that the Australian household is comparatively exposed to a much higher level of debt compared to the Japanese household. Take another look at the Japanese household balance sheet again. In Japan, deposits account for 51% of household finances, and mortgages only 12%. Compare that to the Australian experience where just 23.9% of the household balance sheet is in deposits, and mortgages (owner occupier and investor) account for 38.7% of the household balance sheet (not including home value so we can compare with the BIS numbers). And if we compare the financial surplus of assets versus liabilities then Japan has a healthy 75% surplus, whereas Australia has a much less healthy 58.7% financial surplus.

Much worse than the US at 68%, France and Germany at 68%, and the UK at 62%. That’s why our central banking boffins are keen to keep the inflation tap running. It’s got nothing to do with inflation helping to grow the economy or keeping the economy strong. Inflation is nothing more than a devious attempt to keep the population under the influence of the banks. Because without inflation there’s less need for consumers to rely so heavily on loans from the banks. And if the banks don’t lend as much then that means their profits suffer and asset prices tend not to rise. And again, who suffers most in that instance? That’s right, the banks. We can only hope that the US Federal Reserve and the Reserve Bank of Australia are ultimately just as hopeless with their attempts at ramping up inflation as the boffins at the Bank of Japan have been. But until that happens, Australians can be guaranteed to see their real wealth decrease as their debt liabilities and phoney asset prices increase.

Cheers. Kris Sayce For Money Morning Australia