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Gold, Greenbacks, And Government Intervention

I remember reading a rather significant article by MarketWatch’s Peter Brimelow last fall. As someone who follows precious metals religiously, I had already been aware of the claims made by groups such as the Gold Anti-Trust Action Committee, or GATA, that the price of gold is being manipulated. However, on October 18, 2007, Brimelow let “the cat out of the bag,” so to speak, for the readers of that particular Dow Jones website. Brimelow wrote:

Nevertheless, for the longer term, the gold bug faction lead by Bill Murphy’s LeMetropole Cafe Website is cockahoop. It has long argued that the metal’s price has been repressed by what it calls “The Gold Cartel” an alliance between the official sector (central banks, the U.S. Treasury) and chosen instruments (key investment banks and co-opted bullion dealers and others) to create a financial assets boom.

Reason for rejoicing: The discovery by James Turk of the Freemarket Gold & Money Report that, as Turk puts it: “the U.S. Treasury quietly made a subtle change to its weekly reports of the U.S. International Reserve Position, which includes the U.S. Gold Reserve. This change was first made May 14… It says the U.S. Gold Reserve is 261.499 million ounces and importantly, that the gold is now reported ‘INCLUDING GOLD DEPOSITS AND, IF APPROPRIATE, GOLD SWAPPED’ (emphasis added).

This description provides clear evidence that the U.S. Gold Reserve is in play. Gold has been removed from U.S. Treasury vaults and placed on deposit, presumably in the couple of bullion banks the Treasury has selected to assist with its gold price-capping efforts. Gold placed on deposit gets loaned out by these bullion banks, and then sold into the spot market to try capping the gold price.”

Intervention, pure and simple as that. No, manipulation. Which, by the way, isn’t as conspiratorial as it sounds. Brimelow pointed out:

It may seem like an arcane point. But I remember when the idea that central banks were systematically selling gold at all was dismissed as crankishness. Yet it’s now universally acknowledged.

And why would Uncle Sam want to cap the gold price? The MarketWatch columnist wrote:

Turk’s conclusion: “This new evidence provided in the U.S. Treasury report as well as the rising gold price itself suggest to me that we are now witnessing the last scramble by the gold cartel to cap the gold price. It is a vain attempt by them, acting under the instructions of the U.S. Treasury, to make the world think the dollar is worthy of being the world’s reserve currency when in fact everyone knows that it is not. In short, the wheel has fallen off the truck. The dollar is heading for a train wreck. Use whatever metaphor you want, but the message is clear - the dollar is in serious trouble…

Fast forward to the present day. According to MarketWatch’s Laura Mandaro tonight, currency traders now suspect that American and European finance officials engaged in some “arm-twisting” at last month’s G7 meeting in an attempt to provide support to the U.S. dollar. Mandaro wrote:

Gains of 2% to 5% in the U.S. dollar from a key low point last month, combined with recent press statements from anonymous senior finance officials, have fostered suspicions that the group of industrialized nations backed up their public statements with some backdoor negotiations.

Madaro referred to an analysis of euro and dollar trades by Greg Anderson, head of foreign exchange strategy at ABN AMRO, which suggested “the U.S. and Europe may have pressured central banks from the BRIC countries– Brazil, Russia, India and China– and sovereign-wealth funds to temporarily stop converting 20% to 40% of their newly accumulated U.S. dollar-holdings to the euro.”

This pressure, along with signs that the European economy is struggling, could help explain why the greenback has stabilized. Mandaro suggested that analysts now suspect finance officials, especially from the United States, changed tactics around the time of the G7 meetings. The MarketWatch reporter wrote:

The Treasury Department, while officially supporting a strong dollar policy, had been content to see the dollar slide since it helps U.S. exports, analysts said. That laissez-faire approach seems to have changed in the last two months, as the U.S. government has seen the weak dollar help push up oil, agricultural and other commodity prices to record highs.

Disturbingly, some are making claims of direct government intervention in the market. However, Mandaro noted:

But many currency analysts say such a direct intervention is unlikely.

For one, the United States’ foreign exchange reserves are relatively small at about $75 billion, making dollar buy-backs little more than symbolic.

And the G7 statement, at least at the time, didn’t suggest a direct intervention was round the corner. The last time the U.S. dollar experienced a coordinated currency intervention, when European monetary authorities in September 2000 convinced other G7 members to support the then-depressed euro, the policy statement specifically mentioned the euro. This most recent time, the statement just mentioned exchange rates in general.

The United States doesn’t usually intervene: From August 1995 through December 2006, the United States only intervened twice in the foreign exchange markets.

“Last time.” “Doesn’t usually.” And what’s to say government intervention isn’t occurring this time around?

So much for the notion of “free markets.”

Sources:

“Gold bugs: ‘We told you so…’”
Peter Brimelow
MarketWatch, October 18, 2007

“Dollar rally, leaks put fresh focus on G7 meetings”
Laura Mandaro
MarketWatch, May 15, 2008

Congress Approves National Colosseum

Not really. But Capitol Hill politicians might as well allocate funds to build one, complete with chariot races and gladiators to keep us happy, considering the way they’re pandering to the masses these days. When Congress only has a 20% approval rating (Gallup), what else would you expect? Something like what happened today. Hoping to sooth the economic pain (and gain the electoral support) of Joe Six-Pack and Suzy Soccer Mom, both the U.S. Senate and House of Representatives, in a direct challenge to President Bush, voted to temporarily halt the shipment of thousands of barrels of oil a day into the government’s emergency reserve. The Strategic Petroleum Reserve, a system of underground salt domes on the Gulf Coast, was created by the U.S. government in the seventies as a precaution against major interruptions of oil supplies. With 701 million barrels in storage, it is currently 97% full, yet the equivalent of only two months of oil imports.

The Senate voted 97 to 1 in favor of suspending the shipments, which average about 70,000 barrels a day, until the end of the 2008. Only Senator Wayne Allard of Colorado voted against the measure. Presidential hopefuls Barack Obama and Hillary Rodham Clinton also voted to halt the shipments as well. John McCain was not present for the vote. Mirroring the same bipartisan support as in the Senate, the House voted 385 to 25 in favor of halting the program.

For some time now, Congress has wanted to tinker with the SPR, jawboning on and on about how curbing deliveries to and/or drawing from the emergency reserve (by the way, what part of “emergency” don’t you get?) can ease tight oil supplies, curb market speculation, and possibly lower crude oil prices. Case in point. MSNBC’s John Schoen wrote back on May 19, 2004 (that’s right, 4 years ago):

With oil prices stuck above $40 a barrel, attention has turned to the U.S. Strategic Petroleum Reserve, a vast stockpile of oil stored underground that the U.S. continues to add to. While Democrats call for releasing some of those reserves to help ease oil prices, President Bush Wednesday repeated his long-standing position that the stockpile should only be used in the event of a critical cutoff of fuel needed to maintain the country’s national defense…

“Since the price of oil is so closely tied to inventory levels, filling the SPR under these market conditions both depletes private sector inventories and pushes up prices for America’s consumers,” said Sen. Carl Levin, D-Mich., in a floor speech in April defending an amendment to defer SPR purchases.

More recently, New York Democratic Sen. Charles Schumer has introduced an amendment to draw 1 million barrels a day from the reserve for the next 30 days.

“Joey, do you like movies about gladiators?”

And Congress’ assertions that curbing shipments to and/or drawing from the SPR could help with our supply problems, dampen speculation, and lower oil prices? Wrong, wrong, and wrong, according to the experts (or, at least, people who know what they’re talking about). Regarding the supply problem, the 70,000 barrels that are being sent to the reserve on a daily basis represents only 0.3% of the 20 million barrels consumed by Americans each and every day. 0.3%? Can anyone tell me how this could possibly help alleviate tight supplies? Regarding the perception that high oil prices are caused by speculators, legendary energy investor T. Boone Pickens told attendees at the Oklahoma State University’s Energy Conference on April 23:

Only 5 percent of oil is in the commodity pool. If you did run it up, it would be briefly. Speculators cannot move it that much.

He would know. Finally, a number of politicians believe (or want us to believe) that halting shipments and even drawing from the SPR will somehow lower oil prices. CNN Money’s Steve Hargreaves wrote today:

A statement from Speaker of the House Nancy Pelosi, D-Calif., said it could bring down gas prices by as much as 24 cents a gallon.

Or so she claims. The CNN Money staff writer also wrote:

The U.S. Energy Information Administration predicts oil prices would fall by only about $2 a barrel - or shave 4 to 5 cents a gallon off the price of gas - if the president suspended deliveries to the SPR.

“It’s a very small amount” of oil going into the reserve, said EIA oil market analyst Doug MacIntyre. “And it’s very transparent to the market.”

Should I believe House Speaker Pelosi or the EIA? Tough call, right?

Here’s something to think about. A possible explanation for the high price of crude oil is that global demand is running at 87 million barrels per day, while the global oil supply is at 85 million barrels per day. Furthermore, while older oil fields are starting to go dry, no suitable replacements are being found. Finally, even though the U.S. economy is slowing, for every 1 barrel of reduced American demand there are 14 barrels of increased demand from developing countries like China, India, and Brazil.

Oh, but this just in…

“Middle East Oil Cut Off By Coordinated Attacks Throughout Region” and “Gulf Oil Infrastructure Destroyed By Category 5 Hurricane”

Well done. Thanks for saving me that nickel.

Sources:

“Senate votes to halt oil reserve shipments”
H. Josef Hebert
Associated Press, May 13, 2008

“House votes to stop adding to oil stockpile”
Tom Doggett
Reuters (UK), May 13, 2008

“Debate flares over strategic oil stockpiles”
John W. Schoen
MSNBC, May 19, 2004

“Oil stockpile a drop in the bucket”
Steve Hargreaves
CNN Money, May 13, 2008

“Pickens: Oil to go to $150 a barrel”
Jerry Shottenkirk
Journal Record, April 24, 2008

Who’s To Blame For The High Price Of Oil?

I read the following the other day in a grocery store publication on Chicago’s northwest side. Regarding the high cost of oil and gasoline, the bureau chief of the paper wrote:

Whew! What is the answer? I think we should contact our elected officials, both state and national, and let them know we, the taxpayers, need some relief. Yes, I know about Bush’s economic stimulus package that is on the way- but I don’t want to put it all in my gas tank.

There’s no use arguing with most Americans over who’s to blame for high oil and gasoline prices. In their minds, “Big Oil” is the culprit, with a dash of President Bush, his oil buddies, and every level of government sprinkled in for good measure. But before you forward on that e-mail about a “gas station holiday” to five of your friends, consider this: Could it be possible that the high price of crude oil is mainly due to the basic principle of supply-and-demand? Just a thought. Bloomberg’s Mark Shenk wrote today:

China, India, Russia and the Middle East for the first time will consume more crude oil than the U.S., burning 20.67 million barrels a day this year, an increase of 4.4 percent, according to the International Energy Agency in Paris.

And here in the good old US of A?

U.S. demand will contract 2 percent to 20.38 million barrels daily, the IEA says.

Shenk noted that economic growth in China and India of more than 8%, coupled with increasing car ownership among the countries’ combined populations of 2.45 billion people, will more than compensate for declining demand in the United States. According to the IEA, global oil use will increase 2% this year largely because of emerging market growth.

Regarding the topic of car ownership, China’s passenger car sales jumped 22% to 6.3 million units sold last year. Reuters’ Joe Mcdonald reported on the Chinese auto sector today, and wrote:

Auto sales in China are booming, with analysts and automakers forecasting growth at 15-20 percent this year. But demand for the biggest vehicles is even stronger, with sales of luxury cars and SUVs expected to surge by 40-45 percent…

“Chinese buyers typically like bigger cars and they have the resources to go for them,” said Tim Dunne, J.D. Power’s director of Asia-Pacific market intelligence.

Source: China Daily

Mike Wittner, head of oil research at Societe Generale SA in London, told Bloomberg:

Does the U.S. matter anymore? Has the U.S. mattered for the last few years? It is debatable. As far as the oil market is concerned, demand growth is going to be continued to be driven by China and the Middle East.

Still feel like contacting your elected officials?

Sources:

“Emerging Market Oil Use Exceeds U.S. as Prices Rise (Update2)”
Mark Shenk
Bloomberg, April 21, 2008

“Gas guzzlers a hit in China, where car sales are booming”
Joe Mcdonald
Reuters, April 21, 2008

Banks May Write Down Additional $300 Billion

Yesterday, global strategy consulting firm Oliver Wyman said in a new study that an additional $300 billion in write-downs related to the U.S. subprime mortgage meltdown may be announced by banks before the crisis is over. Back on January 18 I noted that write-downs had already surpassed $100 billion. In a press release picked up by Yahoo! Finance yesterday, John Colas, Managing Director and head of the North American Corporate Strategy Practice at Oliver Wyman, said:

The credit crisis is unlikely to resolve itself before the end of this year. We also see strong likelihood of price corrections in emerging markets and this combination will extend the value loss and turbulence witnessed in 2007.

The management consultancy said in its “State of the Financial Services Industry” report:

We expect a stormy 2008. While governments, central banks and regulators scramble to address the aftermath of the sub-prime fallout, several other crises are mounting.

These other disruptions include:
• A significant slowdown in European real estate markets, especially in Spain and the UK
• The continued weakening of the U.S. dollar
• A collapse in commodity prices
• A fall in Chinese and Indian stocks

The financial services industry should expect “turbulent conditions for 2008 and beyond.” Oliver Wyman predicted that American banks are especially at risk. From its 2008 report:

North American financial services firms will have a tough year. Market uncertainty, combined with further write-downs and expected home-price and loan-volume declines, implies more squeezes on earnings. Banks most likely will have to increase loan-loss reserves.

In North America last year, the financial sector lost 13% in market value, second only to Japan. In contrast to the United States, the value of financial companies in Canada grew 12%.

For the first time since 2002, the global market value of the industry fell, according to the annual report. Controlling for exchange rates, the industry lost 7% of its market value last year. While $300 to $400 billion was gained in red-hot emerging markets last year, financial institutions lost more than $1 trillion in mature economies.

Stock Markets Fall Around The Globe

Returning to work on Monday is hardly ever fun. Losing a ton of money makes it even worse. While American financial markets were closed in remembrance of Martin Luther King, Jr., stock markets around the world were being hammered.

Indexes in Japan, China, Hong Kong, India, South Korea, and Singapore fell at least 3%. Indian stocks were punished severely, dropping nearly 11% at one point in the trading session before finishing off more than 7%. The Australian and New Zealand stock markets have now experienced losing sessions for 11 and 13 days, respectively.

Photo from DailyHaHa.com

The carnage in equities spread to Europe. The pan-European Dow Jones Stoxx 600 index ended down 5.4% at 309.67. At one point earlier in the trading session, the index earlier reached a low of 308.69, which was the largest one-day percentage drop since the September 11 terrorist attacks. The index has lost around 23% from its mid-2007 high of 400.99. The French CAC-40 index ended the day down 6.8% to 4,744.45. The German DAX 30 index was down 7.2% to 790.19. The U.K. FTSE 100 index declined 5.5% to 5,578.20.

Making its way to the Americas, the global sell-off spread to Canada and Latin America. The S&P/Toronto Stock Exchange composite index sank 4.7% to end the day at 12,132.14. Brazil’s Bovespa fell 6.6% to 53.694, and Mexico’s Bolsa index declined 4.8% to 25,444.

According to MarketWatch today, losses from financials were largely to blame after U.S. bond insurers came under attack by a ratings agency, and the proposed economic stimulus plan from President Bush failed to convince investors that it would be enough to prevent a recession in the United States. The stock sell-off occurred after the worst weekly performance on Wall Street for five years.

All eyes are now turned to Wall Street, which resumes trading Tuesday. As of this afternoon, the Dow Jones Industrial Average futures contract was down 520 points to 11,586, the Nasdaq futures were down 76.25 to 1,773.25, and the Standard & Poor’s 500 futures had fallen 60.3 to 1,265. According to MarketWatch:

If futures contracts traded on a day when U.S. stocks weren’t even due to open are anything near accurate, then markets will be in for a major decline on Tuesday, with concerns about bond insurers and the health of financial institutions dragging markets lower.

Vanguard Founder Says Recession Odds At 75 Percent

Earlier today, CNN Money posted the answers to questions Fortune readers asked of John Bogle, the 78-year-old founder of mutual fund giant Vanguard. With $1.3 trillion in assets, Vanguard is now the second-largest mutual fund company. Bogle talked about the odds of a U.S. recession, the U.S. housing market, the subprime crisis, and challenges to the U.S. economy, among other issues.

What are the odds of a recession right now?

I would put the odds of a recession at 75 percent. This economy is very much consumer-based, and I believe that 70 percent of the GDP is consumer spending. That’s a very high number. Two things are happening there: Consumers have fewer resources because from 2001 to 2005 they took $5 trillion out of real estate. That will not recur. This is a big drop. We also see weakness in auto sales and retail spending - we even see it at companies like Starbucks. There is another, equally important factor in consumer spending, and that is confidence. Consumers are not going to spend if they are worried about the future.

Will the real estate market improve anytime soon?

It doesn’t look so good. I really don’t see it improving soon. At some point homes will have to be built. But right now there is not much incentive to build new places when there are so many old places on the market. When those lines cross I don’t know. It’s complicated by the fact that many people have gotten into ARMs [adjustable-rate mortgages] who didn’t know what they were doing. I don’t know what is going to happen to those people when lenders foreclose. When banks were community banks, they were more careful. But when banks sell loans in a bundle, they are clearly not going to be concerned about mortgage quality. So we have to have a better system in the future to make sure we have a much better element of credit quality in mortgages.

How does the U.S. subprime mess compare with other crises you have seen in your career?

I’d say the most similar example was the S&L crisis of the late ‘80s and early ‘90s. The issues were somewhat the same: Institutions borrowed short and lent long.

The immediate concern for most investors is the subprime market, but over the long term what do you see as the biggest challenges facing the U.S. economy?

Externally, we are faced with $1.5 trillion already poured into Iraq and Afghanistan. So you have enormous expenditures in a corner of the world that is important to us, but it is very unwise to think we can bring democracy to a place that doesn’t share our values. There are also the challenges from low cost production in China and India. At home, we have a tremendous future financial problem with the federal deficit. We’ll have to take action on Social Security someday. Government spending has gotten to the point where we will have to either cut spending or raise taxes. Another problem is this deadlocked Congress. And I see the quality and caliber of our presidential nominees, and I am not impressed.

It raises the question of whether this country is even able to run itself anymore.

Morgan Stanley Asia’s Chairman Issues U.S. Recession Warning

Morgan Stanley Asia’s chairman, Stephen Roach, spoke to Sky News earlier today while visiting Australia and warned that while the U.S. economy is entering a recession, the Federal Reserve, along with the rest of the world, doesn’t appear to grasp its significance. While the Fed cut interest rates the last time they met, Roach feels their work is far from done. He said:

They will move again, most assuredly. The US is going into a recession, they’ve a lot more work to do. They could cut their policy short term interest rate by one to 1.5 percentage points over the next nine to 12 months.

During the interview, Roach spoke about the indifference of the global economy to the prospect of an economic recession in the United States. He warned:

There is a view that the world has somehow decoupled from the American growth engine. I think that view will turn out to be dead wrong and this is a global event with consequences for Asia and Australia.

The head of Morgan Stanley Asia also told Sky News that he didn’t believe growing demand from India and China will be able to “save the global economy.” He explained:

The US is a US$9.5 trillion consumer. China is a US$1 trillion consumer. India’s a US$650 billion consumer. Mathematically, it is almost impossible for the young dynamic consumers of China and India to fill the void that would be left by what is likely to be a significant shortfall of US consumer demand.

Back in a November 2 post, I discussed Roach’s views on “decoupling,” which he shared in a speech given in Mumbai, India:

I think the thing that worries me the most, and this is where I would really underscore the point for you in India, is that equity markets in this region, including your own, are discounting this optimistic, rosy scenario called decoupling. There is the strong belief that because the US has slowed so far, and Asia hasn’t, that any further slowdown will leave Asia unscathed. Think about it for a second. The slowing that’s occurred in the US right now has been in homebuilding activity. It’s America’s least global sector. You stop building a house in America, there’s almost no impact on Asian exports to the US. The slowing that will be coming over the next year will be in the consumer demand sector, which is America’s most global sector. So, we are going to see the US slowdown go from a domestically driven to a globally driven slowdown. I am sorry, as bullish as I am about Asia, Asia will not be an oasis of prosperity in a softer global demand climate. To the extent that emerging market equities are buyers of the global decoupling thesis, including in your own market right here, I think there could be a significant correction in emerging market equities that certainly could hit the Indian stock market quite hard.

Roach is well-known on Wall Street as a perennial “bear” on the U.S. economy. In November 2004 (while still Morgan Stanley’s chief economist), he attended a meeting with a select group of fund managers and shocked the audience with his observation that the U.S. had no better than a 10% chance of avoiding an economic “Armageddon.”

Yale’s Shiller Warns Of Major Global Correction

Somehow, I missed this story. Didn’t see it in the mainstream financial media, as it was probably deemed too gloom-and-doom to print. On November 18, ArabianBusiness.com talked about this year’s Dubai International Financial Centre (DIFC) Week. At the gathering, Robert Shiller, the Stanley B. Resor Professor of Economics at Yale University and author of the New York Times bestseller Irrational Exuberance, warned that a sharp downward correction is due in the global markets as real estate, stocks and energy soar to record highs. You may recall that in his bestselling book, Shiller waned that the U.S. stock market of the late nineties had become a bubble that would eventually pop. These past few years, he told anyone who would listen that the U.S. housing boom that came on the heels of the bust on Wall Street also shared the characteristics of a bubble.

According to the website, Dr. Shiller told attendees that while emerging markets like China, India, and Brazil continue to grow, speculative “bubbles” are appearing in the global markets, which could pop and cause a major global recession. He explained:

Perhaps we have gotten a little too confident in the global economic growth. The problem is high oil, stock and real estate prices. I believe that a substantial part is speculative bubble thinking. We have gotten too confident of the prices in these markets.

The global credit crunch has curtailed the lending and borrowing frenzy that fueled price run-ups in energy, stocks, and real estate. As a result, the markets could face significant corrections ahead. Professor Shiller said, “The unwinding of these markets is the most serious risk facing these markets today.”

Sunday Edition: November 25, 2007

Subprime Mortgage Crisis Growing
According to the Wall Street Journal yesterday, calculations by the Bank of America Corp. show that interest rates are set to rise on $362 billion worth of adjustable-rate subprime mortgages in 2008. Banc of America Securities, a unit of Bank of America, estimates that $85 billion in subprime mortgages will reset this quarter, another $85 billion will reset in the first quarter of 2008, and $101 billion of mortgages will reset in the second quarter of 2008. The estimates include loans packaged into securities and held in bank portfolios. In addition to the $362 billion of subprime ARMs that are scheduled to reset during 2008, Banc of America Securities said $152 billion in other loans with adjustable rates are scheduled to reset next year, including “jumbo” mortgages of more than $417,000 and Alt-A loans, a category between prime and subprime.

According to the Journal:

Many of the subprime mortgages that have driven up the default rate went bad in their first year or so, well before their interest rate had a chance to go higher… Now the real crest of the reset wave is coming, and that promises more pain for borrowers, lenders and Wall Street. Already, many subprime lenders, who focused on people with poor credit, have gone bust. Big banks and investors who made subprime loans or bought securities backed by them are reporting billions of dollars in losses… The reset peak will likely add to political pressure to help borrowers who can’t afford to pay the higher interest rates.

The Mortgage Bankers Association estimates that 1.35 million homes will enter the foreclosure process this year with another 1.44 million homes in 2008, up from 705,000 in 2005.

U.S. Recession May Harm Emerging Markets
London-based HSBC Asset Management told Reuters yesterday that an economic recession in the United States will affect emerging markets, even though some believe that decoupling from U.S. growth has taken place. Christian Deseglise, head of HSBC AM’s $85 billion global emerging markets business, told Reuters that the possibility of a U.S. recession was looking real now compared to earlier this year. Deseglise said:

Talk of recession in the US economy has increased lately so the story of decoupling from the US economy is being looked at more carefully … this may be causing the latest bout of nervousness. In February-March, there were fears but no evidence of slowdown. Now we are not dealing just with fears, but with something that is really out there. There are real issues with many sectors that may have a slowdown impact on the rest of the world.

Deseglise talked about the fallout from a U.S. recession:

If the US were to go down to one percent growth, emerging markets have the inner strength to grow within themselves. But if the US were to enter into a prolonged and severe recession that will have a detrimental effect. Emerging markets don’t need a fast growing US economy but they still need a growing US economy… I don’t think a recession is priced into the market.

HSBC Asset Management wouldn’t be the first to dispel the notion of decoupling from the United States. On November 2, I talked about how Stephen Roach, Chairman of Morgan Stanley Asia, told an audience in Mumbai, India, that he didn’t buy into the theory of decoupling:

I think the thing that worries me the most, and this is where I would really underscore the point for you in India, is that equity markets in this region, including your own, are discounting this optimistic, rosy scenario called decoupling. There is the strong belief that because the US has slowed so far, and Asia hasn’t, that any further slowdown will leave Asia unscathed. Think about it for a second. The slowing that’s occurred in the US right now has been in homebuilding activity. It’s America’s least global sector. You stop building a house in America, there’s almost no impact on Asian exports to the US. The slowing that will be coming over the next year will be in the consumer demand sector, which is America’s most global sector. So, we are going to see the US slowdown go from a domestically driven to a globally driven slowdown. I am sorry, as bullish as I am about Asia, Asia will not be an oasis of prosperity in a softer global demand climate. To the extent that emerging market equities are buyers of the global decoupling thesis, including in your own market right here, I think there could be a significant correction in emerging market equities that certainly could hit the Indian stock market quite hard.

Supporters of decoupling disagree. Reuters said:

Some observers say solid fiscal and monetary policy, healthy balance of payments, and China’s rise as a counterweight to the United States has helped emerging nations decouple from US growth and act as a safe haven from developed market turmoil.

In addition, they argue that the United States takes in just 16% of emerging market exports now, compared with 25% in 2001. In 2006, exports to other emerging nations overtook the volume of goods and services sent to developed nations.

Parting Shot
On the Euro Pacific Captial website, president and investment advisor Peter Schiff talked about how the actions of Wall Street and the U.S. government are forcing Gulf and Asian nations to reconsider their efforts in propping up the U.S. economy. In “Heads We Win, Tails You Lose” from November 23, Schiff said:

Perhaps the icing on this “let them eat cake” mentality was provided by Wall Street itself. In a year with record losses, Wall Street firms announced that they would also be paying record bonuses to their employees. The rationale for this PR fiasco was that since the losses were not the fault of the employees (really?), they should not be made to suffer. So rather than sharing the pain being endured by their firms’ shareholders (clearly even less culpable then themselves), Wall Street’s fat cats will rub salt in their owners’ wounds by compounding their losses with the additional expense of lavish bonuses. Following the outlandish pay packages already given to ousted CEO’s who clearly were responsible for the losses, Wall Street’s “heads we win, tails you lose” attitude will not go over well abroad.

Enjoy it while it lasts… which won’t be for much longer.

Have a wonderful week,

Christopher E. Hill
Editor
editor@boom2bust.com

Gold: Barbarous Relic Or Investment Superstar? Part 2

In part one of a three-part series on gold, I noted that the price of the metal has risen significantly in the past year, despite all the arguments leveled against gold by its detractors. Meanwhile, the metal looks to be headed for its seventh straight annual gain. Gold bulls point to the following as having a significant impact on its price in 2007:

U.S. Dollar Weakness- The U.S. currency is down four out of the last five years, and has dropped almost 11% so far this year based on the Federal Reserve’s U.S. Trade-Weighted Major Currency Index. This autumn it’s been at its weakest against the euro since the European currency started trading in 1999, the lowest against the Canadian dollar since it was floated in 1950, and at a 26-year low versus the British pound. The end of the U.S. housing boom, the subprime mortgage crisis, and a credit crunch, in conjunction with forecasts for a slowing U.S. economy, have weighed down the U.S. currency. The increased threats from dollar diversification by countries holding large numbers of greenbacks in their foreign currency reserves, sovereign wealth funds looking to exchange their dollars for other assets, and more nations looking to decouple their currencies from the U.S. dollar have only made matters worse for the world’s reserve currency. Assuming the existence of a strategic inverse relationship between gold and the greenback, investors have poured money into the precious metal and related investment vehicles. Validating such actions have been forecasts by legendary investors such as Warren Buffett, Jim Rogers, and George Soros, who all predict that the U.S. dollar is going lower. Back on October 25, Buffett was quoted by CNBC as saying, “We are still negative on the dollar. We bought stocks in companies that are earning their money in other currencies.” On November 15, Rogers told Bloomberg that, “If you have dollars, I urge you to get out. That’s not a currency to own.” Finally, on June 2, AME Info reported that Soros said, “A slowdown in the United States will be transmitted to the rest of the world via a weaker dollar.”

Geopolitical Risk- The continuing stalemate between the West and Iran over its nuclear program, political instability in Pakistan, and Turkey’s spat with Iraq are just some of the more recent geopolitical risks that have driven the price of gold higher. The ever-present danger from Al-Qaeda should not be forgotten either. Consider the following warning from Michael Scheuer, a 22-year veteran of the Central Intelligence Agency (CIA), where for 6 years he was in charge of the search for Al-Qaeda leader Osama bin Laden. When asked by Radio Free Europe/Radio Liberty earlier this year if he expected more attacks on the United States or in the West on the scale of September 11, 2001, Scheuer’s response was:

Oh, I think greater than 9/11. I don’t think it will happen in Europe, but I do think it will happen in the United States. Bin Laden has been very clear that each of Al-Qaeda’s attacks on America will be greater than the last, and I think the only reason we haven’t seen an attack so far is that he doesn’t have that attack prepared. But when he does, he will use it. And try to get us out of the way, which of course is his main goal.

Stephen Walker, director of global mining research at RBC Capital Markets, said last week that increasing geopolitical risk, combined with combined with rising economic uncertainty, “should continue to provide incentives for investors to increase their exposure to gold as a safe haven.”

Supply and Demand- Last Friday, the Telegraph (UK) announced:

The era of ‘peak gold’ has arrived. Try as they might, miners cannot find enough ore at viable costs to replace their fast-depleting reserves, even if they dig miles into the centre of the earth.

The global mine supply of gold peaked in 2002, and has fallen every year since. Last year alone, the mine supply of gold fell 15%. Also in 2006, South Africa, the world’s single-largest gold producer, produced its lowest amount of gold since 1922 with overall output down 72% since its 1970 peak. It should be noted that no major new mine production is expected in the near-term either.

On the demand side, RBC Capital Markets noted last Wednesday that demand is rising as consumption increases in China, India, and the Middle East. On Thursday, a study by precious metals consultant GFMS Ltd. showed that global gold demand in the third quarter rose 19% year-on-year on the back of robust inflows into bullion investment funds and improved jewelry consumption. The report revealed that the increase in investment demand replaced jewelry buying as the major source of growth for the third quarter. Demand grew sharply in India, China, Turkey, and the Middle East, while it slowed in the United States.

Outside of U.S. dollar weakness, geopolitical risk, and supply/demand factors, gold bulls say that some of the drawbacks which Bloomberg’s Michael Sesit spelled out in part one are actually advantages to owning the precious metal. Critics of gold like to point out that it “doesn’t earn a return.” Michael J. Kosares, President and Founder of Centennial Precious Metals, Inc., argued in his book The ABCs of Gold Investing, that:

Those who criticize gold because it fails to offer a return do not really understand gold’s position as the fixed North Star of asset value around which all other assets rotate. Gold is a stand-alone asset. It relies on no individual or institution for value. Gold investors prefer it this way. In the ultimate sense, this is what money is and what money should be.

Another criticism directed at gold, said Sesit, is “the world’s biggest holders of gold, major central banks, aren’t overly eager to keep owning it.” If so, gold bulls ask why central banks hesitate to unload the metal. In 2006, net central bank sales amounted to just 319 tons, less than half of the 659 tons recorded in the previous year.

Love it or hate it, bulls and bears, gold is here to stay. In the final part of this series, I will talk about where this precious metal may go from here.

(Part 3 will be posted on Wednesday)

U.S. Recession Will Affect Asia

Stephen Roach, Chairman of Morgan Stanley Asia, gave a speech earlier today in Mumbai, India, where he talked about the U.S.-Asian economic outlook. Roach is well-known on Wall Street as a perennial “bear” on the U.S. economy. In November 2004 (while still Morgan Stanley’s chief economist), he attended a meeting with a select group of fund managers and shocked the audience with his observation that the U.S. had no better than a 10% chance of avoiding an economic “Armageddon”.

On the probability of recession in the United States, Roach told his audience:

I want to make three points with you today in my discussion. Number one, I think the global economy is going to be very challenging over the next couple of years. Unlike the situation of 10 years ago, when global problems were made in Asia, I think global problems will be made in America. I think the risk of a recession in the US in 2008, is high and rising. You don’t want to put any real precision on probabilities like that, but I would say it’s a number. Now that has unfortunately moved above that 50% threshold for 2008.

On how a U.S. recession will affect Asia:

Second point I want to make is, if the US goes into recession, you are going to feel it in Asia, you are going to feel it in India. The fundamentals for Asia are terrific. But Asia as a region, and developing Asia in particular, remains very much an export led region, maybe a little bit less than that for India than typical developing Asian economies. But certainly the case in Eastern Asia and China are on the leading edge of that. So, if the US sneezes, Asia will catch a cold. I don’t believe in global decoupling and I will tell you why as we go through this discussion.

On why he doesn’t believe in the theory of “decoupling”:

I think the thing that worries me the most, and this is where I would really underscore the point for you in India, is that equity markets in this region, including your own, are discounting this optimistic, rosy scenario called decoupling. There is the strong belief that because the US has slowed so far, and Asia hasn’t, that any further slowdown will leave Asia unscathed. Think about it for a second. The slowing that’s occurred in the US right now has been in homebuilding activity. It’s America’s least global sector. You stop building a house in America, there’s almost no impact on Asian exports to the US. The slowing that will be coming over the next year will be in the consumer demand sector, which is America’s most global sector. So, we are going to see the US slowdown go from a domestically driven to a globally driven slowdown. I am sorry, as bullish as I am about Asia, Asia will not be an oasis of prosperity in a softer global demand climate. To the extent that emerging market equities are buyers of the global decoupling thesis, including in your own market right here, I think there could be a significant correction in emerging market equities that certainly could hit the Indian stock market quite hard.