GOLD & US$

by Eric Hommelberg
November 26, 2006

In case you’ve missed it, the euro broke out above the 1.30 mark for the first time April 2005. This certainly doesn’t bode well for the dollar and is clearly bullish for us gold bugs indeed. Needless to day the recent dollar drop reflects the lack of confidence in the once almighty dollar and supporting the dollar by buying up ever increasing dollar quantities seems to be impossible since many of the large dollar holding countries are looking for ways to diversify out of the dollar. This piece will focus on the forces dragging the US dollar down thereby strengthening the investment case for gold.

• ·         Gold, a serious hedge against a depreciating dollar?
• ·         Deficits, do they really matter?
• ·         Experts warn for potential dollar crisis

Gold, a serious hedge against a depreciating dollar?

Gold is often referred to as the anti-dollar so thereby given the status of a ‘currency’ . Gold is referred to as the anti-dollar since it is a perfect hedge against a falling dollar.

The chart below makes it painfully clear that gold is a perfect hedge against a falling dollar indeed. The chart shows the inversed dollar against gold during phase I of the bull market in gold.

Conclusion: Gold is a perfect hedge against a depreciating dollar.

Now that was the first phase of the bull market in gold and whatever happened next was something that (almost) no gold expert had predicted. Gold took off all the way up to $730 without the support of a further dropping dollar. The only gold expert out there predicting this could happen was GATA’s Bill Murphy. GATA predicted at their historic Gold Rush 21 conference in Dawson City August 2005 that gold could explode to the upside without the support of a further depreciating dollar. GATA says that gold can explode to the upside due to the impossibility of the major central banks to suppress the price of gold for a much longer period of time. It goes far beyond the scope of this article in order to explain why GATA think so but it should be noted that GATA’s view is gaining popularity fast. A good example concerns an extensive gold report issued by one of Europe’s biggest banks ‘Credit Agricole’ early this year in which they endorsed GATA’s view. The Credit Agricole report can be downloaded here at: http://www.gata.org/files/CheuvreuxGoldReport.pdf

OK you’ll say, so if gold can manage to go up without the support of a further depreciating dollar then why worry any longer about the dollar?

Well, good question. First of all I have to stress that as a staunch GATA supporter I strongly agree with GATA’s Bill Murphy, the price of gold could go higher without the support of a further declining dollar indeed. But the thing I want to point out here is that a further dollar decline is very bullish for gold since as we saw above gold is a perfect hedge against a depreciating dollar and major players will start looking for hedging the risk of a further depreciating dollar soon. Don’t believe it? Well read on:

George Kapasakis, a senior foreign exchange trader at Mizuho Corporate Bank in Sydney recently said:

“Central banks will use gold as a fourth currency instead of the dollar, euro and yen” to hedge exchange-rate risk, Gold will be underpinned.” END

China Should Buy Gold, Central Bank Adviser Says

China should use its foreign-currency reserves, the world’s largest, to buy gold and oil as a hedge to guard against the risk of a sudden drop in the U.S. dollar, said an adviser on the central bank’s 13-member policy board. END

UAE considers cut in dollar reserves

By Peter GarnhamMon Oct 30

The United Arab Emirates, the second-largest Arab economy, signalled on Monday that it might cut its holdings of dollars by almost half, highlighting a recent trend of reserve diversification away from the US currency.

Sultan bin Nasser al-Suwaidi, the governor of the central bank of the United Arab Emirates, told a meeting of central bankers from Gulf states in Abu Dhabi that the bank wanted eventually to lower the dollar's share of its foreign currency reserves to a range of 50-90 per cent. Currently the UAE holds 98 per cent of its $25bn foreign exchange reserves in dollars and 2 per cent in euros.

"It is our investment policy to diversify," said Mr al-Suwaidi. "We are still waiting for the appropriate time."

Mr al-Suwaidi said that the central bank was still planning to convert as much as 8 per cent of its dollar holdings into euros - a scheme it first proposed in March amid fears that the US currency was set to depreciate. END
 

Bond Strategists: Japan's Insurers May Shun U.S. Debt

Oct. 31 - Japanese life insurers, who manage the equivalent of $1.6 trillion in assets, will cut holdings of U.S. Treasuries after the cost of protecting the investment against currency swings surged, according to Calyon Securities.

A reduction in purchases by Japanese investors, the largest overseas holders of U.S. government debt, may push up yields, said Susumu Kato, chief strategist at Calyon. Japan held $644.2 billion of the securities at the end of August. END

Costello seeks orderly $US withdrawal
John Garnaut Economics Correspondent
October 18, 2006

TREASURER Peter Costello has called on East Asia's central bankers to "telegraph" their intentions to diversify out of American investments and ensure an orderly adjustment.

Central banks in China, Japan, Taiwan, South Korea and Hong Kong have channelled immense foreign reserves into American government bonds, helping to prop up the US dollar and hold down American interest rates.

Mr Costello said "the strategy had changed" and Chinese central bankers were now looking for alternative investments. END.
 

Chinese plans to diversify reserves into gold provides further support
Marketwatch.com Nov 09

There was further support in comments from Peoples Bank of China Governor Zhou Xiaochuan who said at a Frankfurt conference that China has very clear plans to diversify its currency reserves, which now stand at more than $1 trillion. A wide range of instruments are under consideration, including gold and oil. END.

It ain’t no secret that fear for a further depreciating dollar finds its roots in the US sky-rocketing current account deficit. Now let’s examine how and why total US debt is growing at an ever increasing pace and why this can’t go on for ever..
 

Deficits, do they really matter?

Before going into this question let’s first take a peek at the exploding US trade deficit

Well, pretty ugly picture right? What does it tell us? It simply tells us that the US is importing much more goods than it exports. In fact the US is living far beyond its means. In order to finance the exploding US deficits an inflow of foreign capital to the tune of $3 billion dollar each single working day is required. The scary part however is that the required inflow of foreign capital increases at an ever increasing pace year by year. It’s no secret that (specifically Asian) foreign Central Banks  have  been massive buyers of US debt which is illustrated  well in the chart below: 

What we see here is an ever increasing pace of appreciation of Central Bank FX Reserves. This is clearly not sustainable and simple logic tells us that all what is not sustainable simply stops. In other words, without foreign support the US$ is in deep trouble.

Now if the soaring trade deficit wasn’t already bad enough, the picture only worsens when looking at total US debt which clocked an alarmingly $44 trillion last year. The chart below speaks for itself:

As you can see here total US debt is growing faster than its national income. Ever tried to run a business which its debt grows faster than its income? Well, needless to say you would be heading straight into bankruptcy.

Is that what worries major dollar holding nations? Is that why they’re looking for dollar alternatives? How is the US going to solve its debt problem? Can they solve it? Or is it already too late? Well, serious questions indeed and you may wonder why authorities have chosen the path of denial and continue to present an ‘all is well’ good news show. Or maybe the authorities are telling the truth and the picture painted above is extremely exaggerated to the down-side. Well, facts are facts and the simple fact is that the US is addicted to an inflow of  foreign capital to the tune of $3 billion dollars each single working day and when that foreign support stops the US$ is in deep trouble.

Now let’s take a peek of some serious expert warnings regarding a potential dollar crisis:

Experts warn for potential dollar crisis

According to  Prof. Laurence Kotlikoff (a former  senior economist at the President’s Council of Economic Advisors (CEA) during the first Reagan administration) the US is heading towards bankruptcy indeed. Kotlikoff was quoted this summer by the Daily Telegraph:

 “A ballooning budget deficit and a pensions and welfare timebomb could send the economic superpower into insolvency, according to research by Professor Laurence Kotlikoff for the Federal Reserve Bank of St Louis, a leading constituent of the US Federal Reserve.

Prof Kotlikoff said that, by some measures, the US is already bankrupt. “To paraphrase the Oxford English Dictionary, is the United States at the end of its resources, exhausted, stripped bare, destitute, bereft, wanting in property, or wrecked in consequence of failure to pay its creditors,” he asked. According to his central analysis, “the US government is, indeed,bankrupt, insofar as it will be unable to pay its creditors, who, in this context, are current and future generations to whom it has explicitly or implicitly promised future net payments of various kinds’’. END.

You don’t have to be a rocket-scientist in order to understand that a world reserve currency backed by a country heading into bankruptcy won’t generate that much confidence therefore a massive exodus out of the dollar can be expected coming years and is in fact already taking place, a fact even former FED chief Alan Greenspan recently acknowledged:

WASHINGTON (Reuters) - Former Federal Reserve Chairman Alan Greenspan said on Thursday that both private investors and central banks were shifting away from the U.S. dollar and toward the euro. “We’re beginning to see some move from the dollar to the euro, both from the private sector ... but also from monetary authorities and central banks,” Greenspan told a conference sponsored by the Commercial Finance Association. END.

Now shifting away from dollars toward euros isn’t really a dollar bullish development, in other words, the dollar seems to be heading lower, a view which is shared by China’s deputy central bank chief:
 

China Raises Red Flag On Dollar
Forbes.com Nov 24

"The exchange rate of the U.S. dollar, which is the major reserve currency, is going lower, increasing the depreciation risk for East Asian reserve assets," wrote Wu Xiaoling, deputy governor of the People's Bank of China, in an academic paper. Wu is ranked by Forbes as the 35th most powerful woman in the world. END.

So a depreciating dollar seems to be inevatible coming years but what if the dollar depreciates in a disorderly way, could it morph into a dollar (financial) crisis then? Well, sure enough no-one knows but serious warnings have been surfacing lately which shouldn’t be taken lightly:

WASHINGTON -- Democratic lawmakers warned on Thursday that U.S. reliance on foreign countries to purchase U.S. debt could lead to a financial crisis as they faulted the Bush administration's economic stewardship.

"If the United States does not begin to take steps to reduce its unsustainable dependence on foreign borrowing in an orderly way, there could be a run on the dollar that could precipitate an international finance crisis and a sharp increase in interest rates," a report issued by Democrats on the congressional Joint Economic Committee and House of Representatives Financial Services Committee said. END.

Investment advisor Bridgewater isn’t too optimistic about the dollar either:
 

Bridgewater's Hennecke Comments on Dollar, Yuan, Yen, Gold

Martin Hennecke, a senior manager at independent investment adviser Bridgewater Ltd. in Hong Kong, comments on the outlook for the dollar, euro, yuan, yen, Swiss franc and commodities. Hennecke spoke in German in a televised interview.

``What concerns us most right now is the U.S. dollar and the decline of the housing market, the crash of the real estate market. Many of the companies that build houses have started to reel. That will have a global effect and could lead to a dollar crash.'' END.

Former FED chief Paul Volcker raised one of his strongest warnings last week concerning a potential dollar crisis, he was very specific and mentioned a time frame of within two and a half years:
 

Reviewing the systemic case for gold investment
AME Info Nov 19

So far the US has organized an orderly devaluation of the US dollar which has fallen by almost a third in value this century. However, in all market mechanisms there comes a tipping point where a trend becomes a rout - and it has to be said that expecting global creditors to continue to accept falling real debts is not sustainable.

This is why an authority as eminent as Paul Volcker forecasts a dollar crisis within the next two-and-a-half years, and why he is unwilling to extend that timeframe according to recent statements. END.
 

Now I don’t know about you but I don’t think there’s a snowball’s chance in hell for the dollar to appreciate substantially coming years. This is important since a sharp appreciating dollar is what is required to stop the advance of gold (as shown earlier)..So when the advance of gold can’t be stopped we will see (much) higher gold prices the years ahead. On November 05 we informed our members that a new upleg in gold had begun (Gold – A New Upleg has begun) and that new highs for gold are in the cards before end of next year. Now what do you think your gold shares will be worth by then?

Yes, we are anticipating a rewarding year of 2007 and we expect the gold shares to perform very well next year. We will continue to explore for new exciting discovery stories among the gold mining companies since we have proven up the concept of discovery investing beyond any doubt this year. Our Discovery TOP 10 clocked an impressive +500% gain so far and as from January 01 next year we will announce a new Discovery TOP 10 for our members and start all over again simply with a performance gain of 0%.

If you want to participate in our hunt for new discovery succes then please sign up today HERE

Eric Hommelberg

The Gold Discovery Letter/
The Gold Drivers Report

www.golddrivers.com