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Mine's Bigger Than Yours

Currency wars over who's got the most money to burn are fuelling the Gold Price rally...

AS THE Gold Price moves through yet another major milestone – $1300 per ounce – some heavy hitters in the marketplace are beginning to wonder if the yellow metal's rally is getting a bit too frothy, or even worse, writes Gary Dorsch, editor of the Global Money Trends newsletter.

Is a speculative bubble brewing – and one which might ultimately deflate under its own weight, leading to a sharp correction? On Sept 15th, famed hedge fund trader George Soros said that Gold Prices might continue to rise, but warned that that gold is the "ultimate bubble"...

"Gold is the only actual bull market currently. It just made a new high yesterday. In the present circumstances that may continue. I call gold the ultimate bubble, which means it might go higher. But it's certainly not safe and it's not going to last forever."

Soros has been bullish on gold in a big way, and as of June 30th, the Soros fund held 5.24 million shares of the SPDR Gold Trust GLD, a stake worth about $650 million today.

Soros's fund also held equity holdings in Gold Mining corporations, plus other minerals, worth almost $250 million.

Over the past two months, there's been a global stampede into precious metals, with investors of many different stripes, and from many countries, scurrying to Buy Gold and silver in both the physical market and through exchange traded funds.

The World Gold Council reported that the demand for gold worldwide surged 36% in the second quarter of 2010, swelling to 1,050 tonnes. The Greek debt crisis, instability in Irish and Portuguese bonds, and expectations the Fed would unleash "Quantitative Easing" (aka QEII) – flooding the world with a new tidal wave of freshly printed US Dollars – has supported the historic bull run. Europe accounted for more than 35% of the retail purchases of Gold Coins during the second quarter.

The latest surge in gold and Silver Prices was sparked in July, following comments from Fed officials signaling that QEII could be around the corner. On July 22nd, Fed chief Ben "Bubbles" Bernanke reassured congressional lawmakers the central bank is prepared to print more Dollars if the US jobless rate continues to hover around 10%.

"We are ready and will act if the economy does not continue to improve, if we don't see the kind of improvements in the labor market that we are hoping for and expecting. Unemployment is the most important problem that we have right now. What we can do is make financial conditions as supportive of growth as we can and we certainly are doing that..."

On August 19th, St Louis Fed chief James Bullard was more explicit, signaling his backing for further monetization of the US government's debt.

"Should economic developments suggest increased disinflation risk, purchases of Treasury securities in excess of those required to keep the size of the balance sheet constant may be warranted. Any additional Treasury buying should be undertaken in a measured, deliberate manner, commensurate with the magnitude of the deflation threat."

The Fed's propaganda artists are operating behind a veil of "smoke-and mirrors", trying to instill the fear of consumer-price deflation amongst bondholders in order to justify another big round of stealth monetization of the US government's debt.

The Fed's first go-around with QE, totaling $1.75 trillion, combined with the Bank of England's £200bn QE-scheme and the Bank of Japan's ¥21 trillion QE-scheme, fueled a powerful rally in key commodity markets in 2009, lifting the Dow Jones Commodity Index (DJCI) from deep in negative territory, and onto the positive side, thus warding off the threat of deflation in the global economy.

However, since the Fed completed its 12-month buying spree in Treasury bonds and mortgage-backed bonds in March 2010, the year-over-year rate of increase in both the DJCI and the US Producer Price Index have petered out. Last November, the DJCI was hanging around the 135-level, just a shade below the 138.40-level that prevails today. If the DJCI stays stagnant or turns lower in the months ahead, it could knock the US-PPI into negative territory by year's end, signaling the onset of another bout of deflationary pressures, and triggering a second round of the Fed's QE.

Thus, on Sept 1st, Philadelphia Fed chief Charles Plosser said the Fed would embark upon further monetary easing if faced with a dangerous downward price spiral.

"If we do need to act, if fears of deflation were to become real, then we would need every ounce of credibility we can muster to convince markets we are not going to let deflation happen...

"I would certainly entertain the solution if I feared deflation, and if I feared that expectations were coming unglued in that direction – then we would have to take actions," he warned.

Interestingly enough, amid all this gloomy talk by Fed officials about the bogeyman of deflation, the demand for precious metals – traditional hedges against inflation and currency devaluations – is booming.

Why? Traders realize that the Fed's magic elixir for fighting the scourge of deflation is more money printing – otherwise known as the nuclear QE-scheme. US bond dealers, who trade directly with the Fed, aren't questioning whether QEII is on the table, but are rather taking bets on the size of the next tranche, with estimates ranging between $300 billion and $1 trillion.

Speculation that the Fed would unleash QEII soon has already spearheaded a new round of currency wars across the globe. Central bankers in Brazil, China, Chile, Japan, Russia, South Korea and Thailand have all stepped up their interventions, by injecting large sums of paper into the currency markets, while trying to prevent a precipitous decline in the value of the US Dollar versus their own currencies.

The amount of foreign currency reserves stashed away in the coffers of the Bank of Korea have climbed by $76 billion since April 2009, to a record high of $286 billion – and becoming the world's sixth-largest after China, Japan, Russia, Taiwan and India. The BoK's currency reserves are an indicator of the approximate size of its interventions in the foreign-exchange market, utilized to artificially hold down the value of the Korean Won vs. the US Dollar.

The value of the US Dollar is critical to Seoul, since Beijing pegs the Chinese Yuan to the US Dollar, and China is the biggest customer for Korean exporters. Thus, the BoK aims to protect its exporters in both the Chinese and US markets. However, the BoK hasn't been able to turn the bearish tide against the US Dollar. It's been overwhelmed by the ideas that the Fed would unleash nuclear QEII. Now the BoK can only try to stem the bleeding – engineering an orderly retreat for the greenback.

The Bank of Korea would of course be much wealthier if it had judged the Gold Price more correctly. The BoK holds only 14 tonnes of Gold Bullion, equivalent to just 0.03% of its total reserves. On Dec 9th, 2009, the BoK's FX-chief, Lee Eung Baek argued:

"There's an illusion in gold. Out of more than 200 nations, how many have bought Gold Bullion? Like other central banks, we have been increasing the types of currency reserves outside the Dollar. Gold offers little value, with no cash returns. Since India and Russia with large reserves bought gold, there's speculation that Korea might buy it too. But we are not classified in the same category. There's a slim chance that we will Buy Gold from the IMF..."

This was when the yellow metal was changing hands at $1226 an ounce, almost $100 below today's price.

On Sept 16th, Tokyo's financial warlords also intervened in world currency markets to drive down the exchange rate of the Yen.

The Bank of Japan sold an estimated ¥2 trillion ($23 billion) to buy up US Dollars. The first such intervention by Japan in more than six years, this was also the biggest ever one-day currency action, and breached a tacit agreement among the Group-of-Seven industrial powers (G7) to avoid unilateral currency interventions.

But Japan had threatened such action for more than six weeks, after the value of the US Dollar declined by 10% from May to a 15-year low of ¥83. The Japanese Yen also climbed sharply in relation to the Euro and the Chinese Yuan...meaning that Japan's multinationals, listed on the Nikkei 225 index – and heavily dependent on exports – were suffering. The Dollar's value had declined far below their average break-even point of ¥93, and threatens their ability to compete in selling goods abroad.

Japan's foray into the currency markets triggered a short squeeze on over-zealous US Dollar bears, and lifted the Dollar as high as ¥86 in short order. However, the Dollar's one-day rally quickly stalled, as speculators began to bet that the size of the Fed's QEII would exceed the size of the Bank of Japan's devaluation schemes. Earlier, the Bank of Japan boosted the size of excess Yen sitting in deposits held by Japanese banks to ¥30 trillion ($350 billion), in an effort to put a floor under the Dollar at ¥84.

Despite the massive size of the Bank of Japan's injections of Yen into the local banking system, it hasn't been able to turn the US Dollar's bearish tide.

That's because currency traders expect the Fed's next round of QEII to trump the size of the Bank of Japan's interventions. Also, US Treasury yields could resume falling further than comparable Japanese bond yields, thus narrowing the US Dollar's interest-rate advantage over the Yen. In the current round of competitive currency devaluations, the Fed holds the trump card over the Bank of Japan.

Most interesting, Japanese 10-year bond yields are flirting with the psychological 1% level, despite the ballooning of the size of Japan's public debt, now at ¥909 trillion ($10.5 trillion). Japan's bond yields are falling, even though its debt-to-GDP ratio is about 180%, which on the surface is worse than 115% for Greece. Yet although public attention tends to focus on Japan's gross debt, which has soared to ¥909 trillion, the government also owns about ¥700 trillion in assets.

That ¥700 trillion in assets includes roughly ¥180 trillion in real assets, such as public office buildings, and ¥520 trillion in financial assets, including stakes in special corporations. The government can sell these assets and use the proceeds to pay down debt. Thus, Japan's net debt is about ¥200 trillion, or about 40% of its nominal GDP, which is over ¥500 trillion per year. Perhaps, this is why Beijing hasn't been afraid to buy ¥1.7 trillion of Japanese government bonds in the first seven months of 2010.

Still, at yields of 1% or less for 10-year Japanese bonds, the only buyers would be short-term gamblers, or those who are convinced that Japan's economy would be snared in the deflation trap for year's to come.

Buying JGB's at yields of 1% or less could lead to large losses over the longer-term. Thus, the more sensible investment for Japanese investors is to Buy Gold against the Japanese Yen. Priced in Tokyo's money, gold has more than doubled over the past five years, and served as a good hedge against the Bank of Japan's printing schemes.

Already, the Bank of Japan is monetizing half of Tokyo's annual budget deficit of ¥44 trillion this fiscal year, and there's pressure on the central bank to buy more government bonds to weaken the Yen. Although some traders might view the Bank of Japan's bond-buying operations as a buy signal for JGBs, investors in Tokyo gold have profited more handsomely. Tokyo gold has been tracking the size of Japan's outstanding debt, since Tokyo's ruling elite prefer to pressure the central bank to monetize its debts, rather than sell-off state owned assets to finance budget shortfalls.

Gold's not just tracking Tokyo's monetary problems, either...

Bank Rossii, Russia's central bank, manages the Ruble against a basket of Dollars and Euros to limit currency swings that may hurt it exporters. In August, Bank Rossii bought $1.1 billion and €136 million, trying to keep the Ruble within a floating range against the Euro-Dollar's basket.

This summer's agricultural drought, the worst in decades, has already shrunk Russia's trade surplus to $8.3 billion in August, or 29% less than a year ago, and has slowed its economy's growth rate to 2.4%, with 60% of the fall attributed to the agricultural sector. Thus, Bank Rossi is liable to start increasing the supply of Rubles in the money markets to limit further damage from adverse exchange rates moves to its economy.

The Kremlin earns most of its foreign currency from the sale of Urals blend crude oil, natural gas, and other natural resources, such as timber, platinum, and nickel. Along with rebounding energy and metals markets, Russia's FX reserves have been replenished to around $478 billion today, from as low as $380 billion in March 2009. Moscow is keen to diversify some of its FX stash into gold, and last May, added 1.1 million ounces equaling 16% of monthly global mining output.

Overall, the Russian central bank bought gold at an average rate of 250,000 ounces per month for the past three years, and now holds an estimated 23.6 million ounces. As of the first quarter of 2010, Saudi Arabia said it had more than doubled its gold holdings from 143 tonnes in Q1 2008 to 323 tonnes this spring, for an average increase of 241,000 ounces a month, or about the same as Russia's purchases.

Thus, gold traders will keep a close eye on the FX reserves of these two key oil producers.

Brazil has also ramped-up its intervention efforts in the foreign currency markets, buying US Dollars twice each day in order to prevent the greenback from falling below its latest defense line at 1.70 Reals.

Largely due to its super strong currency, Brazil's trade surplus fell 44% to $7.9 billion in the first half of 2010, down from $13.9 billion a year ago, as imports grew nearly twice as fast as its exports. Four years ago, the Bank of Brazil (BoB) tried to prevent the US Dollar from falling below 2.10 Reals, but failed in its $100 billion intervention effort.

Currently, the BoB is trying to draw a red-line in the sand for the US Dollar at 1.70 Reals, but Brazil's high short term interest rates, offered at 10.75%, are simply too irresistible to yield hungry investors from around the globe. Foreign inflows of cash into Brazil in the first ten-days of September alone was $2.14 billion. As a result of its relentless intervention efforts, trade surpluses, and foreign direct investment, Brazil's FX stash has grown to $250 billion, and it's the fifth largest lender to the US Treasury.

On Sept 15th, Brazil's Finance chief Guido Mantega vowed to defend the country's exporters, joining other governments worldwide that seek to weaken their currencies as a way of speeding up an economic recovery.

"We will not sit on the sidelines watching the game, while other countries weaken their currencies at the expense of Brazil. We're going to take appropriate measures to stop the real from appreciating," he declared in Rio de Janeiro.

Under conditions of slowing growth in the US economy, there's been an eruption of currency wars worldwide, with an increasing number of governments seeking to secure their share of export markets through outright intervention in the currency markets.

At the heart of the problem, US Senate Banking Committee chairman Christopher Dodd declared China a currency manipulator last week, and said its "economic and trade policies present roadblocks to our recovery." He accused Beijing of stealing intellectual property, violating international trade agreements and dumping goods. Since then, the US Dollar tumbled 1.2% to 6.7035 Yuan.

US Treasury chief Tim Geithner suggested that China should raise the Yuan's exchange rate by at least 20% and issued a thinly veiled threat, noting that "China has a very substantial economic stake in access to the US market." Meaning, the biggest beneficiary of the growing currency trade wars is the precious metals – silver and Gold Investment – now basking in the growing supply of freshly printed paper currency worldwide.

The prospect of QEII by the Fed is prompting other central bankers to counter with currency devaluations of their own. Yes, some central banks such as Banco de Chile, the Bank of Australia, and the Bank of India are going the opposite way – lifting their interest rates, and their currencies have become magnets for foreign capital. But the Fed has concluded that the only expedient weapon in its arsenal to speed-up the US economy is to inject another tidal wave of US Dollars into the banking system, while aiming to artificially inflate the US stock market higher, and thus, create the illusion of greater wealth and better times ahead.

However, when seen through the lens of gold, or in "hard money" terms, the Dow-to-Gold ratio is still trapped near its lows of Q2 2009, highlighting the notion that the US-economic recovery has been mostly limited to Wall Street and US multinationals. Meanwhile, the divide between rich and poor in the US is getting wider. The Dow Industrials' 3,800-point rally from the low of March 2009 was a monetary illusion, and Gold Bullion is still best way to preserve wealth.

Get the safest gold at the lowest prices by using London bullion-market member, the World Gold Council-backed and Queen's Award-winning BullionVault...

GARY DORSCH is editor of the Global Money Trends newsletter. He worked as chief financial futures analyst for three clearing firms on the trading floor of the Chicago Mercantile Exchange before moving to the US and foreign equities trading desk of Charles Schwab and Co.

There he traded across 45 different exchanges, including Australia, Canada, Japan, Hong Kong, the Eurozone, London, Toronto, South Africa, Mexico and New Zealand. With extensive experience of forex, US high grade and corporate junk bonds, foreign government bonds, gold stocks, ADRs, a wide range of US equities and options as well as Canadian oil trusts, he wrote from 2000 to Sept. '05 a weekly newsletter, Foreign Currency Trends, for Charles Schwab's Global Investment department.

See the full archive of Gary Dorsch.


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