Trading forex? Watch out for this costly mistake in trading the Euro as if it's Gold...
RECENTLY at the American Stock Exchange Mike Norman of HardAssetsInvestor.com talked all things forex with Marc Chandler, chief currency strategist at Brown Brother Harriman, the oldest privately-owned bank in the US...
Hard Assets: Marc, many people say that because the Dollar is going down and because oil is priced in dollars, Opec oil producers are going to start shifting out of the Dollar into another currency – say, the Euro or a basket of currencies.
Is this going to happen, in your opinion?
Marc Chandler, chief currency strategist at Brown Brother Harriman: I think it's always possible that something like this could happen, but we think that the odds of it are very slim.
In fact, when you look at the Saudi peninsula and the six Gulf Community Council members, only one of them – Kuwait – has shifted out of the Dollar, and they really shifted to a basket of currencies.
What these countries are doing, they got a lot of their income, of course, by selling oil and getting dollars. A lot of their investments are in dollars, so for them to break the peg with the Dollar, for them to see a major revaluation of the old currencies, would cause some hardship out of their holdings.
Most recently, the gulf community has reiterated that they will stick to the Dollar pegs, and what they're playing for is in 2010, adopting a single currency. It's interesting. What happened is, a Saudi official, who runs their central bank called the Monetary Authority, went to Europe in the middle of February, and it was a perfect forum for him to say, "I'm going to be adopting your currency." But instead he said, "We thought the Dollar was a good purchase," and the Kuwaiti investment authority, which is the second-largest sovereign wealth fund, said the same thing.
So I see no sign that they're about to decouple from the Dollar or break their pegs.
Hard Assets: Well that's good news, I guess, if you're optimistic on the Dollar's fortunes in the medium to long-term. Let's talk about another market, which is Gold.
Historically, people say there is a link between the Dollar's exchange rate and the Gold Market. We've seen gold go up to record levels now in parallel with this decline with the Dollar. How tight is that relationship?
Chandler: Well, it's hard to talk about the Dollar in general. We have to look at individual currencies and look at how they relate to Gold.
And what I show in my work is that the Euro over the last year and a half, two years, roughly moves the same direction as gold about 65% of the time.
I think what happens is that when people want to get out of the Dollar, when they're afraid the dollar is collapsing, they look for the deep alternative, the Euro, which has an economy and capital markets roughly the same as the United States.
Gold is another alternative to paper assets. The money that we have is not backed by gold or silver the way it used to be. So because of that, sometimes people get frustrated or worried about the value of paper assets in general – and gold seems to be a good alternative, especially for those people who live in countries that have weak banks.
Remember what happened to us in the early '70s? We had the Dollar pegged to gold; everybody else was pegged to the Dollar. Our friends the Europeans said they wanted to get more gold than the US was willing to part with, and so their desire to hoard Gold helped collapse the Bretton Woods system.
Now, some 30 years later, the Europeans say they have too much gold, so throughout this whole rally in gold, the European central banks have been diversifying, selling off their gold to buy assets that give a yield stream instead.
So I think that in general, for investors who have a view on Gold – maybe supply-and-demand considerations – they should be buying that. If they have a view on the Euro, they should be trading the euro. The relationship, even when we see a 65% correlation, means that in a two-week period of time, there'll be four days at least when the two don't move in the same direction. That can be very costly for short-term traders.
Hard Assets: Let's talk about one aspect of the forex market that I find curious, as somebody who's been trading in it for almost thirty years. During the entire span of the current administration, the Bush administration, we have seen no intervention. I don't think there's been a period like that in the last 30 or 40 years.
Do you expect to see central banks come in as a counterbalancing force at all ever again?
Chandler: Well, perhaps again sometime, but not right now; not under this president. I think you're right.
President Bush is the first president who has not intervened in the foreign exchange market since at least the end of Bretton Woods and probably even before that. I think that that means a couple things.
One, the bar for intervention is quite high. Secondly, so far the falling dollar has been a free ride for the United States. It hasn't really boosted US inflation, and it hasn't deterred foreigners from buying our assets. Our assets are outperforming in the last six months, in fact, so there has been no cost to a weaker Dollar. And on the margins it helps exports.
So the US has no incentive to really intervene, and if the Europeans are worried, there are two things that they could do to weaken the currency.
Either cut rates, or change their rhetoric.