Tuesday, February 8, 2011

$1,000 gold in a recession?

In my last post, I noted that Jessica Cross, CEO of Virtual Metals, had forecasted $900 gold in 2008. Now, Citigroup (Citibank) sees the possibility of $1,000 gold if the US economy goes recessionary. If we do see a recession, Citigroup ranks gold as the best likely performer, followed by copper, aluminum and zinc, with steel being the worst.
Citigroup observed that “. . . gold is oscillating around $800/oz as speculators have locked in profits. We view the outlook favorable for a test of $1,000.”
The Citigroup analysts see precious metals “as well-positioned” because the Fed and other central banks have made it clear that re-inflation is the operative for the times. Concerns about subprime debt have created what the money men call a “liquidity crisis.” Central bankers always attack liquidity crises by printing more money, which adds to inflationary pressures and makes precious metals more attractive to investors.
Meanwhile, Citigroup analysts warn that “. . . the IMF is taking measures (e.g., job cuts) aimed at convincing the U.S. and Europe to allow 400 tons of gold sales.” If the IMF, which has made rumblings about selling gold for some time, is successful in getting the US to approve gold sales we can expect years of turmoil in the gold market.
However, new comers to the gold market need to know that the IMF and the US were big sellers of gold in the early 1970s when gold had not topped even $200 and silver traded below $2.00. Sales of gold by “official” agencies do not necessarily result in lower gold prices over the long run. However, the short run can be hectic.
What we have to keep in mind is that we are living in highly inflationary times, and that gold and silver have proven to be smart investments during inflationary times.

Reduced scrap gold sales suggest higher gold prices

Gold Fields Minerals Services (GFMS), the London-based metals consultancy, says that the sale of scrap gold in India and the Middle East this year is down compared with prior years. India and the Middle East are “price-sensitive” regions where gold sales usually increase with gold price increases.
However, this year the average quarterly volume of gold sold in India is running less than 20 tons. In 2003 when the price of gold averaged $364, scrap sales ran at about 30 tons a quarter.
GFMS analysts explain the aberration this way: “The most simple explanation appears to be that, as expectations of higher (and ever higher) prices have taken hold, consumers have reduced the amount of old jewellery they are willing to sell back.”
In the industrialized countries this year, scrap gold sales increased with higher prices; however, sales have not kept pace with prior years’ sales. GFMS says that is because of “less of a clear-out from the trade than there was last year,” which means that commercial end users are holding on to their scrap gold.
Supposedly, the jewelry industry, the major consumer of gold, is the best prognosticator of gold prices. So, reduced sales scrap gold sales may suggest higher gold prices.

Ron Paul II

In my December 12, 2007 article Only Ron Paul, I asserted that of the presidential candidates only Ron Paul had the economic understanding to deal with the subprime mess. Now, I present more evidence that Ron Paul is the man to deal with the impending recession. The medicine, however, would be bitter, but the results would be long-lasting. Ron Paul would call for a return to the gold standard.
In 1985, Ron Paul presented a paper to the Mises’ Institute conference on the gold standard: The Political and Economic Agenda for a Real Gold Standard. Nearly 23 years ago, Ron Paul exhibited his grasp of the Austrian Theory of Money and the need for a return to the gold standard. Since 1985, we have seen the devastating results of not being on the gold standard: inflation and the destruction of the dollar as the world’s sole reserve currency.
Because returning to the gold standard seems anachronistic to most Americans (because they do not understand the gold standard and the concept of money), implementing the ideas of Ludwig von Mises, which Paul discusses in his 1985 paper, would be next to impossible. However, Ron Paul discusses another tactic to return to the gold standard, a tactic which should be of interest to gold and silver investors.
Paul asserts that the popularity of gold coins “have shown us that it is possible to adopt another tactic, that of getting gold coins into circulation prior to setting a new par value for the dollar.” (Par value for the dollar meaning the dollar’s conversion rate into gold [and maybe silver.])
In other words, the people would lead the “leaders” in returning to the gold standard. As more and more people turn to gold as protection against inflation and its inevitable result, a declining dollar, they adopt gold as their standard investment. Eventually, our “leaders” will see the handwriting on the wall and return to gold. Returning to the gold standard would be much less painful for the nation if Ron Paul were president. The other candidates, steeped in statist economic theories, would fight returning to the gold standard.
Paul’s piece is an educating read. If you do not grasp all of it, don’t worry. Just by reading Paul’s paper you will inherently know that now is the time to invest in gold and silver.

SA power shortages pressure price of gold

Worldwide concern about the dollar is the primary reason gold has surged to new highs this year. However, the dollar is not the only factor driving the price of gold. A shortage of electric power in South Africa, the world’s largest producer of newly mined gold, is putting downward pressure on the supply.
In South Africa, 95% of the electricity is generated by Eskom, a public utility that now cannot supply enough to meet the country’s needs. The gold mines (and the platinum mines), although South Africa’s economic lifelines because they generate the country’s export revenues, are suffering along with the South African people. Last week Eskom cut power to the mines, which resulted in an industry-wide shut down.
Eskom is between the devil and the deep blue sea.
If Eskom allocates enough electricity to the mines so that they can operate, other consumers will do without, those consumers being not only South African homes but also small businesses. That is a political nightmare for a public utility and the politicians running the country.
However, if Eskom denies the mines the needed power, jobs and export revenues will be lost, further compounding South Africa’s social problems. South Africa has one of the highest crime rates in the world.
If the mines get 50% of the power they need, they can keep the mines open but with no production. The other 50% is needed to mine. If the mines get 90% of what they need, production can be cut not 10% but 20%.
In the last few days, after much lobbying by the mining industry and its supporters, Eskom has been supplying 90% of the power the mines need, which has enabled Anglo Platinum to assert that they will be able to operate at “sustained levels” within two weeks if they continue to get the promised 90%.
Gold Fields has been in constant dialogue with Eskom since having its power needs cut to 80% and has been promised, according to a mineweb.com article, that they will receive the minimum 90% needed to produce.
But a major concern for the mines is the reliability. Can Eskom continue to supply the 90% that the mines say is the minimum needed to operate?
Further, the miners—the guys doing the work—are at great risk if the power is cut unannounced. So far, that has not happened, but it remains a possibility. The power utility previously committed to give the mines at least four hours warning before power supply was shut down or reduced.
Mining in South Africa has always been a great challenge because of the depths of the mines. An unreliable power source makes mining in South African even more challenging.
I visited South Africa in 1979 and made a two-mile vertical drop in a cage attached to a cable (Technically, it was an elevator, but not the type most Americans are used.) into the bowels of the earth where the miners worked. The temperature at the bottom would have been something like 140°F had it not been for the massive—and I mean massive—air conditioning units.
Additionally, there were the electric trains that hauled ore from miles of horizontal shafts. The use of electricity was enormous. Plain and simple: South African mines cannot operate without electricity.
The root of the problems in South Africa lies in the country’s shift toward socialism, but that is a topic for another blog post.
Meanwhile, a one would expect, South African gold shares have not done well since the problem arose. Some analysts say South Africa’s power problems cannot be solved for years. I suspect they will not be solved at all and that in time South Africa will resemble Zimbabwe, which can only be described as a cesspool.
The circumstances in South African are positive for the price of gold, but sad on a human scale. South Africa is a beautiful country with vast resources, but the country is now in the grips of socialism, which, in the ends, spreads misery among the people.

Analysis of proposed IMF gold sales

Resourceinvestor.com has posted an excellent report on the proposed gold sales by the IMF.
Before anyone panics at the idea of the IMF selling gold, I would like to point out that in the 1970s both the IMF and the US Treasury sold gold while it marched to $850. Further, European central banks have been selling gold for years, and gold prices are at record highs.
Additionally, the recommendation for the sales calls for limited sales, maybe up to 400 tons and “sold in a way that didn’t disrupt the market, much like gold sold consistent with the European Central Bank Gold Agreement (EGA), which limits sales to 500 tonnes per year.”
ResourceInvestor notes that past proposals have been blocked by the US Congress, which has, because of weighted voting power, a virtual veto on any IMF gold sales. However, come January 2009, I suspect Congress will have a much more liberal makeup than it now has, and it may not block IMF gold sales, especially with promises of limited sales that are done in a nondisruptive manner.
We may have to put up with IMF gold sales in future years, but the possibility does not dampen my enthusiasm for gold (and sliver). None of the likely presidential winners has any plans to address the massive bleeding of dollars by the US Treasury.
McCain is a war candidate and has said he will continue the occupation of Iraq. McCain has never addressed the financial cost of doing so. Clinton and Obama, while saying they will end the war in Iraq, offer such potpourris of social programs that the dollar will strain under them.
With the likelihood of one of these three becoming president and major shift to the left in Congress (already 21 Republican members of the House have said they will not run for reelection.), I cannot find anything positive for the dollar on the political scene. Although IMF gold sales may turn into reality sometime in the future, I don’t worry about them at all. Investing in gold and silver makes a lot of sense for these times.

Gold in the news

The last few posts were about silver because that’s the way the news fell. Now, we have a plethora of articles about gold, some worth reading and one worth listening to if you prefer not to read.
ANZ Australian Economics Weekly says gold prices may “firm this week.” With gold having hit $930 Wednesday morning, I bet ANZ now wishes they had predicted rising gold prices this week. Analysts love to be right about predicting short-term price moves. Accurate predictions sell subscriptions.
Although ANZ advised that gold could firm this week because of surging oil prices, the analysis warned that concerns about oil prices were “re-setting” global inflation concerns, “which should trigger a catch-up rally in gold (compared to oil).” I guess that’s what we’re seeing with gold up $65 from this time last week.
Nevertheless, ANZ cautioned, “We expect gold prices to drift lower over the coming months, with increasing signs that the fall in the USD is near the trough.” Seasonally, the summer is the low period for gold and silver prices, so there remains the possibility that “gold prices may drift lower over the coming months.” Still, past summers have not had the dollar in so much trouble and real fears that the Bush administration may bomb Iran’s nuclear research facilities.

Mineweb.com reviewed ANZ’s analysis, for those who want to read it
.
Meanwhile, Kevin McArthur, President and CEO of Goldcorp, a major gold mining company, said Tuesday that he is certain that investors will again see four-digit gold prices this year with the potential to “go well into the four digits.” Four-digit means above $1,000, and I guess that “well into the four digits” means something like $3,000 or $4,000 gold. McArthur didn’t give a time frame, but I don’t think he was predicting $3,000 or $4,000 gold this year.
I think that $3,000 – $4,000 gold is a real possibility, out there four to five years. A widened war in the Middle East, and it may not take four or five years.
Mineweb.com ran an article on McArthur’s comments, but the article is mostly about “greens” dominating the conference where McArthur made his predictions.
The third article, which you can listen to instead of read if you prefer, is titled Is the dollar doomed? and is more about the dollar than about gold. Because you can’t talk about a sinking dollar without talking about gold (if you’re giving an honest appraisal of the situation), the article really is quite good. Except where the speaker says, “Well, we don’t actually need a government run gold standard anymore.” Here, he covers himself by saying that there are places where individuals interested in investing in gold can go.
When a government is not on the gold standard, the door is wide open for inflation, exactly what we’ve had in the United States since 1971 when President Richard Nixon closed the gold window.
Meanwhile, resourceinvestor.com slapped gold around a little with an article titled Gold Demand Drops to Five-Year Low in Q1. The article, based on a GFMS study for the World Gold Council, noted reduced demand for gold, with the blame laid at the feet of higher gold prices. In India, for decades the biggest buyer of gold, demand shrank.
Here’ how resourceinvestor.com summed it up:
Gold demand in India, the world’s largest physical bullion consumer, was most severely affected by the movement in the gold price, falling 50% to 102.1 tonnes in Q1. Jewellery and investment demand, at 71.1 tonnes and 31.0 tonnes respectively, were half the levels of the correspondent quarter last year.
In almost an after thought, the resourceinvestor.com article noted:
In marked contrast to India, demand in China grew by 15% to 101.7 tonnes, with both jewellery and investment demand increasing during the first quarter as continued economic strength allowed consumers to increase their purchases regardless of the rising price. Jewellery demand rose 9% to 86.6 tonnes and investment demand surged 63% to 15.1 tonnes.
Somewhere a news outlet should broadcast that China is about to replace India as the biggest buyer of gold. Further, with China’s increasing prosperity and its people freer to buy gold, China’s impact on the gold market should be huge in the years ahead. Wonder why only the perpetual bulls seem to know what’s going on in China when it comes to gold?

Zimbabwean miners get paper for gold

Perhaps the fundamental fear behind every gold investment is that the paper money being gotten rid of could become worthless. In theory (probably in actuality), that fear rests with any currency not redeemable in gold or silver, which means all the world’s currencies. No world currency, not even the fabled Swiss franc can be redeemed for gold or silver at the Swiss National Bank, which is Switzerland’s central bank, the equivalent of the U.S. Federal Reserve Bank.
The destruction of paper money usually comes about after the abandonment of the gold standard and the institution of fiat money, which is money by governmental decree. The dollar is money by decree, “all debts, public and private.” However, in many cases, one fiat currency is introduced to replace another fiat currency. Brazil is famous for doing that.
Before moving on to the problems faced by the Zimbabwean gold miners, I should note that since the Bretton Woods Agreement of 1944, no country has been on the gold standard. The Bretton Woods Agreement established a gold exchange standard, under which the world’s currencies were redeemable in dollars, which were redeemable in gold. Although under the Agreement, currencies’ values were fixed relative to gold, central banks that were presented their nations’ currencies for redemption actually gave the redeemer dollars.
Zimbabwe is an economic cesspool, with government regulations of nearly every facet of economic activity. One control in Zimbabwe is that all mined gold is to be sold to the Zimbabwean central bank, the Reserve Bank of Zimbabwe (RBZ).
According to one source, gold miners are meant to be paid 35% of their production at the highly overvalued local currency and the remainder in US dollars. The RBZ pays partially in U.S. dollars because the gold mining companies need to buy equipment in foreign markets to keep operating. There is no market for Zimbabwean dollars outside Zimbabwe. Outside Zimbabwe, Zim dollars are paper.
While the official policy is for the RBZ to pay partially in U.S. dollars, the RBZ now has no U.S. dollars, or any other foreign currencies, and the gold mining companies are receiving only Zim dollars. Because Zim dollars cannot be spent outside Zimbabwe, the mining companies are unable to replace worn out equipment.
As a result, “Zimbabwe’s once proud and big gold sector could be set for a further decline,” says Tawanda Karombo, posting an article from Harare, the capital of Zimbabwe. Zimbabwe produced seven tons of gold last year compared to 11 tons in 2006, their lowest level in 90 years.
Although Zimbabwe’s gold production has never rivaled that of neighbor South Africa, for nearly a hundred years it has been a solid gold producer. Now, Zimbabwe’s gold production looks set to grind to a halt, which will be positive for gold investing.

Owning and storing gold

My advice on owning and storing gold: buy the physical gold and store it yourself. The form of the gold, be it Krugerrands, American Gold Eagles or gold bars, is not as important as taking physical possession.
CMIGS does not hold or store gold for its clients—we ship it to them—and we strongly warn against trusting a third party to look after one’s gold. Gold is too important to trust to someone else’s care.
However, Americans who put gold or silver in their IRAs have to use precious metals warehouses. For those investors who buy gold (and silver) outside IRAs, we recommend that they secure the metal themselves.
As to whether the gold or silver should be stored in a bank safe deposit box or secured away from a bank is a decision that each gold owner must make. Investors who own their homes have many more storage options than investors who live in apartments. Frankly, we caution against keeping gold in apartments; we think that bank safe deposit boxes are the preferred storage places for apartment dwellers.
A final note on storing gold or silver at home, whether a house or an apartment: never, ever store gold or silver in a bedroom. That’s the first place that a common burglar goes, looking for cash, guns and jewelry.
What about owning “other forms of gold,” such as ETFs, futures contracts and gold mining shares? With ETFs (Exchange Traded Funds) you do not own gold. You own shares in a company that owns gold. You get the price action dollar for dollar with prices of gold, but you do not own gold.
With futures contracts, by going “long” them, you have the “right” to take delivery of the gold represented by the contract when it matures. With futures contracts, you get dollar for dollar price action plus you gain the advantage of leverage, meaning that you have to put up far less money than if you were buying gold for physical delivery, such as from CMI Gold & Silver Inc.
As with ETFs, when you buy futures contracts you do not “own” gold. You have the right to take delivery of the gold represented by the contract when it matures and you pay the full value of the contract. As for the leverage that comes with futures contracts, it also works against you if gold goes down before it goes up. Futures contracts are not suitable for gold investors and should be left to commodity speculators.
Mining shares also provide greater leverage than the outright ownership of gold because stock shares trade “times earnings.” Further, if you select a mining company that makes moves that increases earnings, you usually see the price of the stock rise. But, with stocks, you in no way “own” gold, you own “proxy gold,” which should increase in value if you select a gold mining company that makes good business decisions.
In reiterate, it my position that persons wanting to hedge against inflation and protect against financial uncertainties should buy gold, be it gold bullion coins or gold bars, take delivery of it and secure it themselves. Leaving someone else to look after your gold is risky.
Still, I recognize that some persons’ circumstances are such that buying and storing offshore, i.e., out of the United States, makes sense. In the past, I’ve had no good recommendations for investors wanting to buy offshore other than to seek out a Swiss bank. Now, though, I do.
BullionVault is a highly-professional precious metals firm owned by Galmarley Limited, a UK-registered company located in West London. BullionVault offers its clients choices of storage in London, Zurich and New York. Obviously, if you choose New York, you are not going offshore, but with BullionVault you have the option of storing precious metals either in London or Zurich.

Buffett warms to gold; warns against the dollar

In his annual address to Berkshire Hathaway shareholders, famed investor Warren Buffett warned of the dangers of holding dollar-denominated investments. Buffett’s concerns about the dollar stem from the world’s governments “solutions” to the ongoing financial crisis:  The dollar is headed south, and “You can bet on inflation,” he told shareholders during a six-hour question and answer marathon.
Although having dabbled in gold and silver in the 1960s and having made his now legendary 130 million-ounce purchase in 1998, Buffett cannot be labeled a goldbug. He has always favored income producing investments. However, his strident attacks on the dollar and criticism of the handling of the financial crisis are certain to be viewed as backdoor recommendations to invest in gold. Where else does one go to protect against inflation and the destruction of the dollar?
Actually, Buffett did have recommendations for his shareholders: be good at what you do and increase your earning power, and (2nd recommendation) own a “wonderful business that does not need capital.”
While these recommendations may sound great, they do not answer this question: How do you protect accumulated wealth against inflation if you no longer choose to work. Buffett can be excused for overlooking this. He’s still working at age 78, along with his partner Charlie Munger who is 85.
Other Buffett observations spewed at the Berkshire Hathaway meeting:
The world is in uncharted waters, and nobody knows the exact impact of unprecedented bailout and stimulation packages.
US Government Bonds are among the poorest choices for investors today, especially non-Americans.
The US is following policies that are bound to have inflationary consequences.
The people who are really going to pay (for the bailouts) are those who are buying fixed-interest US government bonds that will be worth less when they redeem them.
While Buffett may not have let the words buy gold bullion or consider investing in silver come out of his mouth, he said them anyway. Mineweb.com has an article on the meeting, as do other financial websites.

Northwestern Mutual buys gold

Spreading across the Internet like a wildfire is the Bloomberg release that “Northwestern Mutual Life Insurance Co., the third-largest U.S. life insurer by 2008 sales, has bought gold for the first time in 152 years to hedge against further asset declines.”
“Gold just seems to make sense; it’s a store of value,” Chief Executive Officer Edward Zore said in an interview following his comments at a conference hosted by Standard & Poor’s in Brooklyn. “In the Depression, gold did very, very well.”
Although many gold investors do not need validation to make them feel good about their gold investments, other investors like to know that such an esteemed institution as Northwest Mutual shares their feelings about how to protect against potential declines in the value of the dollar.
The insurance behemoth has accumulated about $400 million in gold; Zore did not disclose Northwestern’s plans for future gold investing.

Congress to approve IMF gold sales

As noted on this blog before, the IMF wants to sell gold to fund more international welfare programs but must have the approval of the US Congress before it can sell any gold. In a February 2008 post, I speculated that approval under a new Congress would be likely. Now, approval appears imminent.
This week a House-Senate committee will meet to reconcile differences between the House and the Senate in the Supplemental Budget Appropriations Bill. Buried in the bill is approval for the IMF to sell gold. No one is objecting to the sale.
To some, talk of a major institution selling gold is frightening. But, as I noted in the February 2008 post, the gold market has seen IMF sales before and has weathered them nicely.
As the mainstream media report the approval, there may be some downside movement in gold, but at least one gold analyst and investor sees the IMF sale as positive for gold.
Brian Kelly, writing for seekingalpha.com, sees China stepping forward and buying the gold. Kelly doesn’t think that it’s a coincidence that Treasury Secretary Timothy Geithner just ended a trip to China.
By all reports, Geithner avoided all contentious issues with China, such as massive Chinese theft of intellectual property or revaluing the Chinese currency. Instead, he sought a “greater role for China in the International Monetary Fund.”
Kelly further speculates that a sale to China would upset “India and several of the Gulf States as they all have expressed interest in purchasing the gold. If this occurs, nothing could be more bullish for the price of gold.”
Frankly, I haven’t seen anything substantive about India or any Gulf States wanting to buy the IMF gold. But, I guess it could be true. If I were sitting the gargantuan quantities of dollars that those nations hold, I’d want to buy gold. I just wonder if Kelly really has such information or is he, as a gold investor, simply wishing a major buyer would step forward.
Regardless, when news comes out that Congress has approved the sale of IMF gold, it will roil the markets. Bargain hunters may have opportunities to buy on dips in price. And, if Kelly is right about India and some Gulf States wanting to buy the IMF gold, he will certainly be right about that being bullish for gold.

Gold breaks out

Readers of this blog mostly are long-term gold/silver investors who are not concerned with intermediate moves in gold/silver prices except to use dips in prices as opportunities to add to their positions. Still, daily $1 jumps in silver and $20 jumps in gold are of interest to all precious metals investors. If nothing else, investors have wonder if the moves are of significance in the long-term view.
Gene Arensberg, analyst and editor of Got Gold Report, believes that gold’s September 2 price increase of $21.50 was significant in that it was a breakout from a huge consolidation triangle. Arensberg expects the trading to continue in the direction of the trend that preceded the consolidation. The direction of the trend preceding the consolidation triangle was, of course, up.
This is reassuring to investors who have bought in the past few months. Investors who entered the gold/silver market a few years back were long ago confident that they made correct decisions. Technically, the picture is not as clear for silver, but the price action to the upside confirmed gold’s move out of the triangle.
Reassuring to silver investors are the positions reported by the large bullion banks. The nominal sizes of the banks’ short positions in silver were essentially unchanged, meaning that the banks did not add to their short positions as prices rose, which is what they usually do if they expect lower prices in the intermediate. When the bullion banks expect lower intermediate prices, they add to their short positions.
Relative to all commercial traders’ (36 in all) net short silver futures positions, the two bullion banks’ percentage fell from 76.3% to 62.2% over the past month. This is another short-term positive sign for silver investors as it suggests the bullion banks are not yet ready again to take increased short positions in silver.
Arensberg’s analysis also shows the bullion banks lightening their short positions in gold, which may be the reason that gold broke out of the consolidation triangle. Or, the bullion banks may have reduced their short gold positions out of fear that gold was going to break out the triangle regardless of what they did.
Although following what the bullion banks are doing is interesting (sometimes fascinating), the overriding reasons for buying gold and silver are the expansive monetary policies of the world’s central banks, primarily the US central bank, the Federal Reserve System. In the short-run, the bullion banks’ activities will influence the prices of gold and silver, but in the long-run the quantity of freshly-created fiat currencies will determine gold and silver prices.
Arensberg’s Got Gold Report is, in my opinion, the best free technical analysis of the gold/silver market, especially his look at the large commercials’ and the bullion banks’ positions in the gold and silver markets. I encourage gold/silver investors interested in technical analyses to read Arensberg’s Got Gold Report, a copy of which will be posted on www.stockhouse.com in a few days. When the report is up, I will provide a link.

LCs increase gold short positions

My Sept. 7 post noted that gold had broken out from a consolidation triangle, a move that often forecasts still higher prices. And, higher prices we got, with gold hitting an intraday high just short of $1,012.00 in the New York market on Friday, Sept. 11. Silver followed suit, closing at $16.72. However, it was learned Friday that the large commercials (LCs) increased their COMEX short positions in gold to an all-time record high of 270,797 contracts. The previous record was 252,740 contracts, set in February 2008.
It needs to be noted that the reporting cutoff was Tuesday, which means that the LCs had three additional trading days since the report to add to (or reduce) their positions. The common guess is that they increased their shorts, but we will not know until Friday, Sept. 18.
Increases in the LCs’ short positions often have been harbingers of price declines, sometimes precipitous declines over a few days. However, the LCs have not always enjoyed lower prices after increasing their short positions. In fact, the previous record 252,740 contracts in February 2008 came just before sharp price increases. Although the LCs often get it right and get to cover their short positions at lower prices, that is not always the case.
Gold’s mighty move from the summer of 2005 through the spring of 2006, basically a move from $450 to $700, occurred while the LCs carried large short positions, resulting huge losses for the LCs. So, the big boys are not always on the right side of the moves.
If the LCs always increase their short positions on price rises, there have to be times when they suffer losses because gold and silver are in long-term bull markets. Could this be one of those times?
Gold is up three-fold since 2001, from $250 to $1,000. Silver’s 2001 low was just above $4 to just short of $17. This is a great gold/silver bull market, and I don’t see it ending any time soon. If you’re in, buy the dips. If you’re not yet holding physical gold or silver, buy now. Get comfortable with the process. See that the metal you’re getting is real, not electronic impulses on silica bubbles.

IMF sells 200 tons of gold to India

In a move that the gold market did not anticipate, the IMF sold 200 tons of gold directly to India’s central. It was widely known–commented on on this blog February 12, 2008–that the IMF would be a gold seller.
Several years ago, the IMF let known its intentions to sell 400 tons of gold and announced that the sale would be in compliance with the Central Bank Gold Agreement (CBGA) so as not to disrupt the market. Instead of selling under the CBGA, the IMF sold directly to the Reserve Bank of India.
Some analysts are saying that they are surprised that the buyer was India and not China. Actually, I think they hoped that China would be a buyer as the IMF sold under the CBGA. Neither China nor India gave any indications of dealing directly with the IMF.
Now, gold market analysts are speculating that China will take the remaining 200 tons. And, it is pure speculation because no analysts have pipelines to the decidafiers at the People’s Bank of China, as China’s central bank is known. More important, though, a major precedent has been set.
The argument against central banks buying gold has been that the central banks would be cutting their own throats. Since they are major holders of dollars, any purchases of gold would be attacks on the dollar because dollars would be eschewed in favor of gold. Now, the Reserve Bank of India has set a precedent: it is acceptable for central banks to convert large quantities of dollars into gold. Who will be next?
Possibly China, but why not Taiwan or Japan, both major holders of dollars.
I have no doubts but that the bullion houses that are short huge quantities of gold on the COMEX, as discussed in Gene Arnsberg’s latest Got Gold Report, were counting on the IMF sales being dampers on the price of gold. As I speculated in my September 12 post, sometimes the big boys are on the wrong side of the market.
This remains a major bull market for gold and silver. Investors already with big positions have the luxury of waiting on price dips to buy. Investors who have not yet entered the market should consider biting the bullet and entering at these levels. The major news about gold is to be bullish, and there is no way of putting a top on this move.

Rob McEwen sees $5,000 gold

Rob McEwen, who can almost be called a living legend in the gold mining industry, says gold prices may reach $5,000 an ounce – and as soon as 2012 but maybe not until 2014.  McEwen sees loss of faith in the dollar being the reason for gold’s coming rise.
“Money supply has expanded so rapidly that there are a lot more dollars looking for a steady home,” McEwen said in a Bloomberg Television interview. “Governments cannot help themselves. They want to help the economy. They are printing money. They are going into debt on a horrific scale, and that will depreciate the value of the dollar.”
The coming price rise represents a “once-in-every-300-years” phenomenon, McEwen said. He maintained his previous forecast that gold will rise to $2,000 an ounce by the end of this year.
Such forecasts have been made by numerous newsletter writers and usually can be dismissed as hype.  Often, those predictions come in advertisements for their newsletter.  But, McEwen’s prognostication carries weight.
McEwen invests tens of millions of dollars in his beliefs.  Many of the newsletter writers are trying to make their first million.  Still, there are credentialed newsletter writers who have called for gold prices in the multiple thousands of dollars.
Richard Russell, editor of Dow Theory Letters, has written that before this primary bear market in stocks is over, the Dow and the price of gold will meet.  Basically, Russell expects that somewhere in the future we will see something like 3,000 on the Dow and $3,000 gold, but maybe it will be 4,000 on the Dow and $4,000 gold.  Or, maybe it will be 5,000 on the Dow and $5,000 gold.
Jim Sinclair, not a letter writer but an acclaimed commodities investor, sees $1,650 gold this year.  Not as optimistic as McEwen, but nonetheless a rosy outlook.
Philip Manduca, Head of Investment and Chairman of the Investment Committee for ECU Group (London), sees gold topping $2,000 “before 2010 is out.”
Although gold production has fallen in recent years, that is not the driving force behind gold’s price rise over the last decade.  The reason for gold’s ascent is concern about the dollar—and other fiat currencies for that matter.  Considering Washington’s “solutions” to today’s financial woes, investors have reasons to be concerned about the dollar.
The outlook for gold—and silver—is bright.  Rob McEwen says it is very bright.

Central bank gold buying ramped up in 2011

The World Gold Council recently updated its World Official Gold Holdings, as of March 2011.  These are the data that everyone cites when talking about “official” gold holdings.  The report raises interesting issues, all of which are bullish for gold, especially the central bank activity in the gold market. First, China admitted to “long-term purchases” of gold. In April, China’s central bank, the People’s Bank of China, revealed that it had bought 454 tons since 2003. As a result of the purchases, all of which are believed to have come from domestic sources, China now officially owns gold reserves of 1,054 tons and is number five on the World Official Gold Holdings list.
Meanwhile, Russia’s central bank continued to accumulate gold, also primarily by purchasing gold in its domestic market.  Purchases accelerated in the second half of 2009 when Russia’s gold reserves increased by 87.1 tons, versus 30.6 tons purchased in the first six months.  For the year, Russia’s gold reserves increased 22%, to end the year at to 641.5 tons, which now puts Russia in the 9th slot in the table of World Official Gold Holdings.
Of course, the really big news in the gold market in 2009 was India’s central bank purchase of 200 tons from the IMF in an off-market transaction.  Additionally (and generally overlooked), in two other off-market transactions Sri Lanka bought 12 tons and tiny Mauritius bought 2 tons.
When the IMF announced in February last year it was going to sell 403.3 tons of gold, it agreed to do so under the Central Bank Gold Agreement (CBGA), an agreement(s) under which European central banks have been selling gold in coordinated efforts so as not to disrupt the gold market.  However, when India stepped forward, before the IMF could go to the market, half the gold the IMF intended to sell over a five-year period was gone.  Now, there is speculation that the remaining gold will also be sold off-market and not under CBGA.  The IMF has said that it plans to the sell remaining the gold “in a transparent manner.”
Regardless of how the remaining 191.3 tons are sold, the gold market is prepared to handle it.  Monthly CBGA sales slowed rapidly in 2009 and by September had all but dried up.   In December 2009, CBGA sales of only 1.61 tons were reported, compared with sales of almost 43 tons in December 2008.
What is now happening in the gold market is a far cry from the 1990s when the first CBGA was announced.  Then gold was in a bear market and headlines of proposed central bank gold sales (and speculation of IMF sales) roiled the markets.  Now, IMF gold sales only bring speculation as to which central banks will be the buyers.  From day one, I’ve said that IMF gold sales would not deter this bull market.  IMF gold sales are only feeding a voracious demand.

Saudi Arabia gold reserves double what previously reported

According to the World Gold Council, which tracks official gold bullion holdings, Saudi Arabia now holds gold reserves of 322.9 tons, more than double the 143 tons previously reported.  The Saudi central bank, officially the Arabian Monetary Authority (SAMA), did not disclose where the additional gold came from.
Because the WGC gathered the information from a footnote in the latest SAMA quarterly report that read “Gold data have been modified from the first quarter 2008 as a result of the adjustment of the SAMA’s gold accounts,” there is speculation that the central bank had previously owned the additional 179.9 tons but not reported them as official holdings.
Regardless of where the gold came from, Saudi Arabia, which is the world’s fourth-largest holder of foreign exchange reserves, is now the 16th largest gold holder.  This put Saudi Arabia ahead of such countries as Great Britain and Spain.  Still, the Saudi gold holdings make up only 2.8% of the country’s total reserves. The WGC’s Saudi revelation came only a year after China revealed that it was holding 1,000 tons of gold, more than double what it had previously reported for years.
In decades past, any news about central banks was about selling.  So damaging was central bank selling and speculation about still more central bank selling that in 1999 fifteen European central banks agreed to what is now called the Central Bank Gold Agreement, which limits selling by those banks.  The goal of the agreement was to provide for a more stable gold market so as not to damage the third world nations that relied on gold exports for foreign exchange.  Now, some analysts are saying that this year, for the first time in nearly two decades, central banks may be net buyers of gold.
Earlier this year, the Indian central bank bought 200 tons from the IMF.  (Although reported last year, the sale took place officially this year.  Additionally, had India not stepped forward, that 200 tones would have been sold under the Central Bank Gold Agreement.)  Further, Russia, China and other countries are adding to their reserves on a regular basis by purchasing from domestic producers.
While the world is not yet set to go back on a gold standard, it appears that monetary authorities are again recognizing the value of gold.  Undoubtedly, central banks adding to their gold holdings has played a major role in the price of gold reaching record highs.  Continued central bank buying can only add to upward pressure on the price.

Huge reduction in LCs’ net short position in gold

Most gold and silver investors are in precious metals because of macro (big picture) economic and financial circumstances in which the world now finds itself after seven decades of Keynesian economics and statist politics.  These investors are content to take positions in the metals and hold them, while maybe adding to their positions as opportunities arise.
Still, there are other gold and silver investors who follow the markets closely, which usually means monitoring the activities of the large commercials (LCs), which are major players in the gold and silver markets, certainly on the COMEX where their positions have to be reported the Commodities Futures Trading Commission (CFTC).
Among the LCs, the bullion banks are the guys to watch.  They trade for central banks, investment houses, mining companies, refineries, commercial users and other large investment firms when they decide to enter the markets.  The thing to watch is the sizes of the LCs’ reported positions, which has been on the short side for more than a decade.  The big two bullion banks are JPMorgan Chase and HSBC.
For the reporting week just ended, the Commitment of Traders report (COT) showed the largest one-week reduction in large commercial net short positioning for gold since August 12, 2008, says Gene Arensberg in his Got Gold Report.  GGR notes that it’s the fifth largest one-week large commercials’ net short reduction in gold since 2003.  In the past, large reductions in the LCs’ net positions have been harbingers of price moves to the upside.  Not a guarantee, but it needs be remembered that the LCs are the big boys on the COMEX , and when they move they should not be ignored.
Seasonally, the metals have just entered their weak period, June through August/September.  So, the boys backing off on their short positions is interesting.  (In years past, the LCs have added to their short positions during the summer.)  Additionally, gold is trading only 6% above its 200-day moving average, and it is below its 50-day moving average, which means gold may not be as vulnerable to a big decline this summer as it has in past years.  So, the large reduction in the LCs’ net short position in gold may be really significant.
Arensberg’s Got Gold Report presently is free.  Log on at www.gotgoldreport.com.  In addition to analyses of the gold and silver markets, Arensberg also offers what he now calls his Vulture Bargain Hunting candidates: low-priced and high-risk gold mining stocks that he believes to be good speculations.  Purchases of such companies should only be done by persons financially (and emotionally) capable of sustaining losses.  Gene does good work, but he would be the first to tell you that speculative mining stocks are not the place for retirement funds.
GGR also offers COT Flashes, which are email updates of the COT reports.  This is a convenient way to be appraised of what’s happening with LCs’ short positions in gold and in silver.
As noted, access to www.gotgoldreport.com presently is free.  Plans are afoot for Gene’s work to be a subscription service.  Now, though, it is free.  Gold and silver investors who closely follow the markets may want to visit the site and sign up for the COT Flashes.  However, after the site becomes a paid subscription, the COT Flashes will be part of the paid subscription.

Gold & Silver Breakout

In the September 11 interview with Eric King of King World News, I mentioned that a number of credible analysts were saying that gold and silver looked like they were about the have a technical breakout to the upside.  Gold’s and silver’s price action since have confirmed those predictions.
In the interview, I warned long-term investors to be prepared for volatile price action because such a move will bring technical traders to the gold and silver markets.  These traders will not be there because of concerns about a declining dollar or the stability of the world’s financial structure, but solely because of the price action.  When they perceive the move to the upside to be over, or they have hit their price targets, they will bail out, thereby adding to the metals volatility.
So, as prices march higher, investors need to be prepared for some sharp corrections.  This is not a prediction that a correction is imminent, only a warning that somewhere in this move there will be sharp downside moves.  Considering the present state of financial affairs worldwide, physical gold and silver investors need to hold on and definitely not try to trade any intermediate moves.
Over the years, during various precious metals bull markets I have seen investors attempt to trade intermediate moves only to be left on the sidelines as the metals marched high.  Many times they accurately picked intermediate tops but failed to get back in before prices moved up again.
 As the old, seasoned veteran said in Reminiscences of a Stock Market Operator, “It’s a bull market.  Get your position and hold on.”

Central banks turning gold buyers

For the CBGA (Central Bank Gold Agreement) year to end September 30, central bank gold sales are estimated to be 6.2 tones, down 96% from their high of 497 tons for the CBGA year ended September 30, 2005, the year for the highest sales under the CBGA.  Over the last ten years, central banks sold 442 tons a year on average.   With this about-face, it is like a couple of gold mines shutting down.  But, the news gets still better for gold investors.
According to the Financial Times, the gold market analysts at GFMS estimates that central banks as a group will be buyers of gold this year for the first time since 1988. On a net basis, the Times reports, are forecast to be small, at around 15 tons. Large official purchases of gold – in the hundreds of tons – have not been seen since 1965, prior to the collapse of the Bretton Woods system of fixed exchange rates linked to the gold price.  (In doing this analysis, obviously the Times ignored (missed?) the 200 ton purchase by the Reserve Bank of India from the IMF.)
For two decades, central banks roiled the gold market with sales and announcements of sales.  Could gold ever rise again, supposedly sage analysts asked, with central banks holding half the world’s supply of gold?  It was an accepted Establishment position that selling gold and moving the funds to sovereign debts was a smart move.
The most ignominious seller was the UK Treasury, which announced in May 1999 that it would be selling half of Britain’s gold reserves.  Prices plummeted on the announcement, yet the UK Treasury sold.  Today, Gordon Brown, then Chancellor of the Exchequer, still has egg on his face for that move.  The UK averaged less than $300/oz for its gold.  The UK sales were undoubtedly responsible for gold hitting a 23-year low at just above $250 an ounce.
Other central bankers saw the brilliance (sic) of Brown’s move and joined in the selling.  Spain halved its gold holdings, and France started a program of large disposals.  The Financial Times calls it a gold rush – but in reverse. For nearly 20 years the world’s central banks, including the central banks of Canada, Switzerland, Belgium and Australia, sold their once prized gold bars
From 1990 until last year, central banks around the world sold about 7,500 tons of gold. Over the last decade, the 442 tons central banks dumped each year, on average, add up to more than the annual output of China, the world’s biggest gold producer.  The 442 tons equals about 10 per cent of annual demand.
Now, though, things have changed as central bankers and investors alike have come to recognize the dangers of owning assets that can be created at will.  Consequently, central gold sales that were relied on for years are, essentially, no more.
Additionally, big mining companies, AngloGold Ashanti being the latest, have moved to eliminate their hedge books.  This, along with central banks becoming net buyers, means less gold on the market at a time when investor demand for gold is increasing daily.

Gold buyers question viability of banking system

In a recent interview, Eric King of KingWorldNew.com asked me why CMIGS customers are buying.  “Is it concern about inflation, the dollar or the economy?”  he asked.  My answer was that most buyers comment on concerns about the world’s financial structure.  Will the banking system survive?  Craig Stahl of Problem Bank List has put up a blog post that confirms why investors are turning to gold (and silver).
According to Stahl, “a recent Rasmussen poll indicates a great sense of unease regarding the stability of the US banking system.  ‘Only 8% are very confident in the stability of America’s banks, while 11% are not at all confident’.  In addition, the survey shows that ’54% lack confidence in the stability of the US banking industry.’   Prior to the financial crisis, 68% of the public had confidence in the banking system.
“Rasmussen’s survey also showed that 32% of Americans are ‘at least somewhat worried’ and 8% are ‘very worried’ about the money they have on deposit in the bank.  Most of the American public still professes to be unconcerned about losing money in a banking failure, despite the admission by government officials that the entire financial system was on the precipice of collapse in 2008.”
That Americans are worried about the banking system but mostly are unconcerned about losing money in a banking failure does not surprise me.  Ingrained in Americans is not necessarily faith in the FDIC, which guarantees deposits, but a strong belief – and a correct one, I believe – that fedgov will not let any depositors suffer any losses, which could precipitate a bank run.
Problem Bank List counts 129 failures so far this year.  And, not a depositor has lost a dime.  Further, bank failures, except in the state of domicile, rarely get any news coverage.  People in general simply are not concerned.  However, the people who are buying gold and silver state that they are.
Problem Bank List further notes that this year’s banking failures are on track to outpace the 140 banking failures of 2011.

Abundance of gold articles, not all bullish

Mineweb.com, a South African-based website dedicated to the mining industry, is an excellent source of articles about precious metals.  With contributors around the globe, mineweb.com offers wide perspectives.  Today’s issue has four articles and a podcast, most of which should be of interest to investors with gold hitting all-time highs and silver hitting 30-year highs.
BIS taking in more gold – who are the counterparties this time?
The Bank of International Settlements hit the headlines earlier this year when it was discovered that its gold holdings had soared: now it appears BIS gold holdings are on the increase again.
Gold near week high as dollar weakens
The dollar dropped after the Federal Reserve signaled that the US economy may need extra stimulus, pushing the yellow metal up.
BH: Today gold popped again as news sources around the world revealed that indeed the Fed was prepared to create still more money in efforts to get the economy going.  The Financial Times, a widely-read and respected newspaper, headlines: Fresh Fed boost more likely.
The first sentence of the article predicted “that the US will soon launch a fresh burst of ‘quantitative easing.’  Quantitative easing is a new euphemism for the creation of new money out of thin air.  We used to say, “The Fed is printing again.”  Now, we say, “The Fed has started another round of quantitative easing.”
Gold could reach peak in next 3 to 6 months
According to Natixis, the global economy is not in quite as bad a state as many in the market are thinking and as a result the price of gold could reach its zenith in 2011.
“We are projecting that at some point in the next three to six months we will have reached the peak and (gold) prices will decline from then on.  So we will be looking for prices to perhaps fall below $1,000/oz by the end of next year.”
BH: to predict a top in 2011 is bold.  The US is running trillion-dollar deficits, the financial survival of the PIIGS countries is in question, and concerns about the world’s financial structure abound.  Yet someone says gold will top next year.  An impossible call.  However, I will concede that an intermediate top could be put in next year, but at this time I don’t see “prices declining from then on.”
Goldman Sachs raises 12 month gold forecast by 20%
The bank has raised its forecast to $1,650 after a slowing US recovery and falling interest rates drive further investment into the yellow metal.

BH: In another bearish article, the same Nic Brown of Commodities Research Natixis, sees a correction, but he doesn’t know when, which is understandable.
In the Gold could peak in next 3 to 6 months article, Brown predicted a correction in within six months.  In this article, he hedges.  There will be a correction, but will gold climb another $200 before the correction?
Gold’s current fundamentals – Nic Brown, Head of Commodities Research Natixis
“There is the potential for a substantial correction in gold prices – when it’s going to start – very difficult to tell.”
BH: Conflicting, confusing articles are the norm in the second phase of bull markets.  Analysts will disagree with each other, and many observers will find valid arguments on both sides.  In the third phase (and the final), the articles will be uniformly bullish, with hardly a bear around.  In my opinion, the third phase is years away.

Have Asian buyers checkmated silver shorts?

Eric King of KingWorldNews.com blogged that his sources say Asian buyers effectively have checkmated the silver shorts.  No doubt about it, there is a major battle going on in the silver markets.  Volumes are at record highs, and volatility is extreme.
Many clients ask who’s doing all the selling.  CFTC’s COT reports suggest it’s the usually suspects, the bullion houses.  But, a better question may be who’s doing the buying?  Eric King says it’s some Asians, who have brought some really big money to the game.
Undoubtedly, the Fed’s announcement of Quantitative Easing 2, with one noted analyst saying it could bankrupt the Fed.  QE2 has made many people revaluate their desire to hold dollar-denominated investments, such as US treasuries.

Premiums up on physical gold in Asia

The premiums that buyers put on physical forms of gold and silver indicate the level of interest for the most conservative forms of gold and silver.  High or rising premiums indicate strong buying; declining premiums show declining demand; low premiums can indicate low interest but not necessarily.  Sometimes demand can be strong but supplies are sufficient to meet demand.
Mineweb.com reports that concerns about Euro zone debt have pushed gold bar premiums to two-year highs in Hong Kong, where gold bars are offered at a premium of $3 to the spot London prices.  $3 premiums on gold bars in Hong Kong were last seen in late 2008 at the height of the global financial crisis.
Concerns about Portugal seem to be the driver behind Hong Kong buying; and, with gold off its historical high of $1,430 in December, many investors see gold as cheap at the $1,375 level.   Later this week, Portugal will go the bond market to raise funds.  If unsuccessful, Portugal will be the third PIIGS nation to turn to the EU and IMF for financial aid.
Of interest, is China’s entry into the Euro debt market, a development worth watching.  China’s buying of Euro debt, especially PIIGS debt, could more political than for investment purposes.
Greece and Ireland were the first and the second PIIGS to require bailout money.  Spain is adamant that it will not need a bailout, but credit rating agencies think otherwise.  Concerns about Italy are muted at the moment.
Adding to bar demand in Hong Kong is strong demand from China where refineries have been closed for the holidays.  Still, concerns about Portugal are on the forefront.  Even if Portugal finds buyers for its debt, the rate it has to pay will be indicative of the marketplace’s concerns about Portugal.
Presently in the US, premiums are normal, which means that such items as Gold Eagles and gold bars can be bought at premiums that reflect normal markups by wholesalers and by retailers.  Presently, Krugerrands can be bought about $15-$17 cheaper than Gold Eagles.  At times, Rands are as much as $20 cheaper than Gold Eagles.

US Dollar is Safe…For Now

The Dollar is Crashing! The Dollar is Crashing! Such is the perennial claim of doomsday predictors, conspiracy theorists, gold bugs, etc. Those of you who read my blog regularly know that I often come to the defense of the Dollar. Given that it has risen by more than 5% over the last month and is currently hovering around its average value of the last five years, I think this position is worth reiterating.
US Dollar Index 2006 - 2010
In the months leading up to the expansion of the Fed’s Quantitative Easing Program (QE2), investors took an especially bearish view on the Dollar, precipitating a rapid and steep decline against most currencies. Analysts argued (somewhat contradictorily) that QE2 would be ineffective in the short-run and inflationary in the long-run, and that most of the new cash would be invested abroad – where returns are higher – rather than in the US.
Since the unveiling of QE2, however, the Dollar has rallied strongly. On the one hand, most economists remains skeptical that it will do much to lift GDP and boost employment. However, a parallel thread holds that this was only the ostensible motive for QE2, and that the real motive was to prevent the outbreak of another financial crisis and consequent economic downturn. Given that housing prices are headed downward and banks’ balance sheets are still weak, the Fed’s move reads more like a preemptive move to further shore up the financial system than an economic stimulus program.
At the very least, this probably won’t hurt the Dollar, and certainly not to the extent that the market had priced in prior to QE2. While the stock market rally has stalled, the rise in Treasury Yields has not. The 10-Year rate is close to 3% for the first time in months, making it more attractive (and less costly) to hold capital in Dollar-denominated assets. The Dollar was also helped by the release of GDP data for Q3, during which the US economy beat expectations and grew by 2.5%.
10-Year Treasury Rate Vs. S&P 500 - 2006-2010
As a result, traders are reducing their Dollar-short positions. Analysts have revised their forecasts to reflect a stronger Dollar, based on the notion that “The dollar has found a bottom.” At this point, the main naysayers are “overwhelmingly found in the ranks of the opposition Republican party,” perhaps part of a cynical ploy to hurt both the economy and Barack Obama’s chances of being reelected.
To be sure, there may be other reasons for the Dollar’s rally, namely the growing turmoil in the EU. Evidence is mounting that the EU sovereign debt crisis is spreading, which has spurred both an increase in investor risk aversion and a decline in the Euro. Still, market chatter seems to be focusing less on the Dollar as safe-haven and more on the fact that the Dollar was merely oversold.
On a purchasing power parity (ppp) basis, the Dollar is starting to look cheap. If the opinions of Europeans, Canadian, Australian, and Japanese tourists are to be taken at face value, the US is cheaper than it has been for years. As one commentator summarized, “If the PPP figures are right, the U.S. dollar has more upside than the negative sentiment around it would indicate. If the greenback were to decline further, it would have to do so from an already undervalued situation.”

War = Good News for South Korea?

South Korea was in the midst of figuring out what to do with its appreciating Won when disaster struck, in the form of an unprovoked attack from North Korea. Combined with a worsening of the sovereign debt crisis in Europe, the news was enough to send the Won down 5% over the course of a couple weeks. From the standpoint of managing its currency, it looks like the (distant) prospect of war is actually a blessing in disguise.
Over the last decade, South Korea has been one of the world’s largest serial interveners in currency markets. Over the last two years alone, as evidenced by the growth in its foreign exchange reserves, it has spent more than $100 Billion defending the Won. As the so-called currency war has intensified, so, too has the Bank of Korea intensified its efforts to hold down the Won, having spent more than $20 Billion since July towards this effort.
South Korea Forex Reserves 2005-2010
You could say then that South Korea’s hosting of the G20 Summit on November 15 put it in a slightly awkward position. Still, it was determined to make clear that it would continue to take steps to combat the rise in the Won. According to Shin Hyun-song, the special economic advisor to President Lee Myung-bak, “This means that countries can intervene in the currency market when the market is in disorder and when there is a gap between the market rate and underlying economic fundamentals.” Of course, fundamentals is hardly an objective notion in this case.
While the G20 predictably called on participants to “move toward a market-driven exchange rate system and to refrain from competitive devaluations,” it nonetheless also guided them towards “implementing policy tools for bringing excessive external imbalances down to sustainable levels.” The underlying message is that certain countries should curtail their reliance on exports and try to achieve more balanced growth.
Naturally, South Korea’s interpretation was that while direct intervention is now taboo, taxes and other capital controls are sanctioned. Thus, it has been reported that “the Korean government has been gauging its timing to launch further measures to tighten the financial market and protect it from volatile global capital movement..bank levies on non-deposit liabilities and taxes on foreign purchases of government bonds are both possible options.”
As I said, though, the South Korea now has some breathing room. Its Won depreciated rapidly in the minutes after the shelling of Yeonpyeong island, which killed four and wounded 20, was first reported. The fact that the US government immediately pledged its support and solidarity (by sending over an aircraft carrier) is not instilling confidence. One analyst indicated, “We see a strong chance of further Korean won weakness in the days ahead as more details emerge, particularly if public opinion in South Korea puts pressure on the government there to take a stronger stance.”
Korean Won / US Dollar Chart
Even before this episode, the EU sovereign debt crisis had spread to Ireland, and put Spain and Portugal at risk, too. As a result, the Dollar-as-safe-haven mindset re-emerged, and spurred some capital movement back to the US. In this context, the drama with North Korea only exacerbated the climate of risk aversion.
Ultimately, both the EU fiscal crisis and the tensions with North Korea will subside, which should cause the Won to resume its rise. (In fact, Korean exporters have come to view this as inevitable, and have taken advantage of the relatively favorable exchange rate to repatriate overseas earnings). At this point, you can expect the Bank of Korea to begin implementing capital controls and continue the face-off with currency markets.

Asian Currencies Poised to Rise, but for Wrong Reasons

All things considered, Asian currencies have had an okay 2010 (and there’s still another month to go). After a modest first half, they started to rise in unison in June, and several are poised to finish the year 10% higher than where they began. While the last few weeks have seen a slight pullback, there is cause for cautious optimism in 2011.
Asian Currency Chart 2010
At this point, I think the rise in Asian currencies has become somewhat self-fulfilling. Basically, investors expect Asian currencies to rise, and the consequent anticipatory capital inflows cause them to actually rise, thereby reinforcing investor sentiment. For example, the co-head of emerging markets for Pacific Investment Management Company (PIMCO) is “investing in local currency debt and foreign exchange contracts in Asia on the basis that…emerging market currencies are bound to rise for…fundamental reasons.” Upon being asked to elaborate on such fundamentals, he answered lamely that, “One big driver for emerging markets in coming years will come from investors’ relatively low allocations to these fast-growing regions.”
When pressed for actual reasons, investors can glibly rattle off such strengths as high growth and low debt and wax bullish about the emerging market ‘story,’ but ultimately they are chasing yield, asset appreciation, and strengthening exchange rates. It doesn’t matter that P/E ratios for (Asian) emerging market stocks are significantly higher than in industrialized economies, or that bond prices are destined to decline as soon as (Asian) emerging market Central Banks begin lifting interest rates, or that Purchase Power Parity (PPP) already suggests that some of these currencies are already fairly valued. In a nutshell, they continue to pour money into Asia because that’s what everyone else seems to be doing.
Personally, I think that kind of mentality should inspire caution in even the most bullish of investors. It suggests that if bubbles haven’t already formed in emerging markets, they probably will soon, since there’s no way that GDP growth will be large enough to absorb the continuous inflow of capital. According to the Financial Times, “Data suggest that emerging market mutual funds, including those invested in Asian markets, have received about 10 per cent of their assets in additional flows over the past four to five months.” Meanwhile, a not-insignificant portion of the $600 Billion Fed QE2 program could find its way into Asia, exacerbating this trend.
US Dollar Asia Index 2010
In addition, emerging markets in general, and Asia in particular, have always been vulnerable to sudden capital outflow caused by flareups in risk aversion. For example, Asian currencies as a whole (see the US Dollar Asian Currency Index chart above) have declined 2% in the month of November alone, due to interest rate hikes in China and a re-emergence of the EU sovereign debt crisis. The former sparked fears of a worldwide economic slowdown, while the latter precipitated a decline in risk appetite.
As a bona fide fundamental analyst, it pains me to say that emerging market Asian currencies can expect some (modest) appreciation over the next year, barring any serious changes to the EU fiscal and global economic situations. It seems that capital will continue to pour into Asia, which – rather than fundamentals – will continue to dictate performance.

Canadian Dollar: Parity Vs Reality

After a stellar 2009, the Canadian Dollar (“Loonie”) has had a relatively lackluster 2010 against the Dollar, rising by only 3-4%. As the Loonie has inched (back) towards parity, it has encountered significant resistance. I think there is reason to believe that the currency has reached its limit, and that there are little prospects for further appreciation for at least the first half of 2011.
Canadian Dollar  Oil   Commodity Price Chart 2010
Everyone likes to think of the Canadian Dollar as a commodity currency, but I don’t think this is an accurate representation. Net energy exports account for only a small portion (2.9%) of Canadian GDP, a fraction which is dwarfed by the export of automobiles, for example. In fact, eastern Canada, which is comparatively poor in natural resources, is actually a net energy importer. I think that investors have largely come to the same conclusion, and significant rallies in oil and other commodity prices in the second half of 2010 spurred only a modest appreciation in the Loonie.
The currency has risen so fast over the last couple years that Canada has run a trade deficit for six consecutive months, including a record $2.5 Billion in July. (In some ways, doesn’t this prove that economic imbalances will ultimately self-correct?!). In addition, to say that Canadian export sector is heavily reliant on the US would be an understatement: “The U.S. bought 70 percent of Canada’s exports in October, down from 75 percent in June, and a record of about 85 percent in 2001.” It’s no wonder that Canadian economic officials have defended the Fed’s QE2 monetary easing program; they know that Canada’s economic health is contingent on a strong US economy.
As for how fluctuations in risk affect the Loonie, it’s not clear. On two separate occasions, the WSJ reported first that “With investors more willing to take on riskier assets than they were the day before, the Canadian dollar was able to move sharply higher,” and then that “Canada’s relatively strong fiscal and economic fundamentals attract safe-haven flows when investors are fleeing from risk.” What a blatant contradiction if there ever was one! Personally, I think that Canada’s economic structure and relatively high debt levels disqualify the Loonie from consideration as a safe-haven currency. That being said, it has notched some impressive gains against other non-safe haven currencies.
Canadian Dollar Versus Other Currencies November 2010
If not for its low interest rates, nobody would even mention it in the same breath as the US Dollar or Japanese Yen. Speaking of low rates, the Bank of Canada voted last week to keep its benchmark interest rate on hold at 1% and indicated that it won’t consider raising them for quite some time. Said Central Bank Governor Mark Carney, “There are limits to the divergence that there can be between Canada and the United States.” In other words, the BOC probably won’t hike rates until the Fed does, at which point there will be very little basis for buying the Loonie over the US Dollar.
Analysts tend to agree with this assessment: “The loonie will trade at parity by the end of March and weaken to C$1.01 per dollar through the end of third-quarter 2011, according to…a Bloomberg survey: ‘We still think the Canadian dollar will continue to hover around here and test parity; we don’t think the Canadian dollar is going to back up against the U.S. dollar until the new year.’ Interestingly enough, Canadian investment advisers echo this sentiment: “We’re saying to clients that the Canadian dollar is strong right now, so buying U.S. assets is cheaper than it would be if the dollar were weak.”
It’s a bad sign for the Loonie when even Canadians think it’s overvalued.

Japanese Yen Down on Risk Aversion

It seems the gods of the forex market read my previous post on the Japanese Yen, in which I puzzled over the currency’s appreciation in the face of contradictory economic and financial factors. Since then, the Yen’s 6-month, 15% appreciation (against the US Dollar) has arrested. It has retreated from the brink of record highs, and undergone the most significant correction since March of this year. Have investors come to their senses, or what?!
USD JPY Chart
You certainly can’t give the Bank of Japan (BOJ) any credit. Aside from its single-day $25 Billion intervention in September, it hasn’t entered the forex markets. In fact, it has already repaid the funds lent to it by the Ministry of Finance, which suggests that it doesn’t have any intention to replicate its earlier intervention in the immediate future, regardless of where the Yen moves.
Perhaps the BOJ foresaw the current correction in the Yen, which was probably inevitable in some ways. After all, Japanese interest rates – while gradually rising – still remain at levels that are unattractive to investors. While US short-term rates are low, long-term rates are more than 1.5% higher than their Japanese counterparts. When you factor in that Japan’s fiscal condition is worse than the US, there is really very little reason, in this aspect, to prefer Japan. As one analyst summarized, “The whole interest-rate differential argument is turning out to be dollar supportive, at least in the near term.”
The same is true for risk-averse capital. For reasons of liquidity and psychology, the Japanese Yen will continue to be a safe-haven destination in times of distress. Still, it’s hardly superior to the Dollar, in this sense. Inflation is slowly emerging (or at least, the risk of deflation is slowly abating) in Japan, and it could conceivably reach 1% this year if the Bank of Japan has its way. Its proposed 35 trillion yen ($419 billion) of asset purchases dwarfs the comparable Federal Reserve Bank’s QE2 program (in relative terms) and contradicts the notion that the Yen is the best store of value.
Japan Economic Structure - Dependence on Exports
Finally, the Japanese economy remains weak, and vulnerable to a double-dip recession. On the one hand, “Japan’s economy expanded at an annual 4.5 percent rate in the three months ended Sept. 30.” On the other hand, its economy remains heavily reliant on exports (see chart above, courtesy of Bloomberg News) to drive growth, which is complicated by the expensive Yen and concerns over a drop-off in demand from China and the rest of the world. In fact, “Exports rose 7.8 percent in October, the slowest pace this year, while industrial production fell for a fifth month and the unemployment rate climbed to 5.1 percent.” In addition, the closely watched Tankan survey registered a drop in September, “the first fall in seven quarters.” While Japanese companies are still net optimistic, analysts expect that this to change in the beginning of 2011.
For the rest of the year, how the Yen performs will depend largely on investor risk-appetite. If risk aversion predominates, then the Yen should hold its value. In addition, it’s worth pointing out that even as the Yen has fallen against the Dollar, it has appreciated against the Euro, and remained flat against a handful of other currencies. Against the US Dollar, however, I still don’t see any reason for why the Yen should trade below 85, and I expect the correction will continue to unfold.
JPY comparison chart 2010

Chinese Yuan: Appreciation or Inflation?

Based on nominal exchange rates, the Chinese Yuan has appreciated by a modest 2% against the US Dollar since the month of September (when the People’s Bank of China (PBOC) adjusted the currency peg for the first time in nearly two years). If you take inflation into account, however, the Chinese Yuan has risen by much more. In fact, if current trends persist, the Chinese Yuan exchange rate controversy might resolve itself.
CNY USD 1 year chart
Demands from the international community for China to appreciate its currency hinge on two related arguments. The first is that at its current level, the artificially low exchange has allowed China to build up a massive trade surplus. The second is that Chinese prices seem to be lower than they should be (when quoted in other currencies), and the economic principle of Purchasing Power Parity (PPP) suggests that for this discrepancy to be eliminated, the Chinese Yuan must rise.
As it turns out, both of these claims are more problematic than they would appear. For example, China’s official trade surplus is already massive, and is steadily increasing. For 2010, it will probably near $200 Billion. However, it turns out that majority of that surplus is being captured by foreign-funded companies: “Their 112.5-billion U.S.-dollar surplus accounts for 66 percent of China’s total surplus over the past 11 months.”
In addition, trade statistics are calculated in such a way that the country that assembles the finished product gets credit for the full export value of that product. By looking specifically at Apple’s popular iPhone, researchers calculated that the product officially contributed $2 Billion to the US trade deficit with China. When the nuances of the iPhone’s supply chain are taken into account, that figure swings to a surplus of $48 million. In both of these cases, the fact that these products are manufactured in China doesn’t detract from US GDP (though it probably does cost the US jobs). Hence, the US probably isn’t hurting as much from the weak RMB to the extent that some lobbyists insist.
iPhone US China trade deficit
As for inflation, the official rate is now 5.1% on an annualized basis. Even if we accept this (and living in China, I can tell you that the actual rate is much, much higher), that means that the value of other currencies is eroding at a much faster rate than is implied by official exchange rates. That’s because a currency is only worth its purchasing power; as prices and wages in China rise, the purchasing power of the US Dollar (and other currencies) falls.
The Chinese government is trying to address the problem in the form of price controls and mandated increases in supply, but it is still reluctant to rein in inflation using conventional monetary policy measures. M2 money supply in China is increasing at a rate of 20% a year, the majority of which is being spent on another boom in fixed asset investment. While the PBOC has responded by increasing the required reserve ratio of Chinese banks, it remains reluctant to raise interest rates lest it contribute to further inflows of “hot money” on more upward pressure on the Yuan. As a result, the consensus among economists is that inflation will continue rising unabated: “We see a strong chance of underlying price pressures continuing to build over the medium-term.”
China inflation rate 2004-2010
Unless circumstances change, then, the argument for further RMB appreciation is somewhat weak. Nonetheless, analysts remain optimistic: “A Bloomberg survey based on the median estimates of 20 analysts predicts the yuan to increase 6.1 percent to 6.28 percent by the end of 2011.” Given that Hu Jintao is schedule to visit the US in January – and China’s fondness for symbolic policy gestures – a token move of 1% or so before then wouldn’t be surprising. As for the predicted 6% rise next year, well, that depends on inflation.