Nov 23

Ireland: What a Mess!

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But it might just create a chance to Buy Gold and other hard assets on the cheap…

WELL THIS should be interesting, writes Dan Denning in his Daily Reckoning Australia.

The EU/IMF bailout of Ireland is not going off without a hitch. The UK’s Telegraph reports that the Green party, which currently forms the junior half of Ireland’s coalition, might withdraw that support and call for new elections in January. This would call into doubt the ability of the current government not only to execute a deal with the EU and the IMF but also to pursue its four-year austerity program.

What a mess! We’ll get to how Ireland and Australia are similar in a moment. But first, please recall the words of the great philosopher of the New York Yankees, Yogi Berra. He once said, "When you come to a fork in the road, take it."

Today’s fork in the financial road leads down two different paths. One path is continued US Dollar devaluation and a strategic migration to emerging market assets (under the assumption that the BRIICS nations will eventually have to allow for currency appreciation…or face rampant food and fuel inflation). This trade favors Buying Gold, commodities, and tangible assets in general.

But remember what happened in 2008? The Global Financial Crisis actually led to a massive rally in the US Dollar. Emerging markets got hammered. The "risk" trades financed with cheap greenbacks were reversed and commodities took a shellacking as well.

Could that happen again? The boys at Knight Research think it’s going to happen again, but even bigger and badder this time around. In a recent research note, they wrote:

"We believe the structural and cyclical terms of global trade have finally reached their tipping point. This will catalyse a wholesale change in sentiment and a historic repositioning of risk assets. The emerging market global growth story is over."

This is the fork Murray has been preparing for in the Slipstream Trader for our subscribers  It would mean falling indexes in Australia, which would of course mean falling components of those indexes. Knight Research elaborates on this fork:

"The game is over. Presently, we believe that the broad-based resurgence of investor confidence in the emerging market and secular bull market in commodities will end badly; proving that the rally which commenced in Q2 2009, was in fact an ‘echo bubble’ facilitated by massive-and unsustainable-stimuli from the Chinese government.

"We believe that the end of the Great Consumer Credit Cycle and the vast structural differences in the terms of trade between the United States, the EU, and China, have finally caught up with the secular bull thesis on emerging market and commodities.

"Quite ironically, the Fed’s aggressive policies will likely prove to be the catalyst which breaks China’s unbridled expansion of credit and non-economic growth, ushering in a wholesale rebalancing of risk assets."

This is not a lukewarm prediction. It would quite obviously be mega bearish for the Aussie Dollar and for commodities. And thus far, there’s not much evidence to support that giant reversal is afoot that is more bearish for emerging markets than it is for the US Dollar. It’s a fork in the road, though. So we have to take it and see where it leads.

There ARE a few factors supporting the "Game Over" theme. One is that Ireland’s woes are not the last o the Eurozone’s problems. There is Greece. There is Spain. And really, Ireland is not even done and dusted yet. To some extent, Euro weakness is dollar bullish and contributes to the "Game Over" theme.

But the bigger factor is Chinese tightening, or just your basic traditional popping massive credit bubble. There are early signs of that. Last week China raised reserve requirements on banks again. And Citigroup agrees with our assessment that rising food prices in China could be bearish for metals.

China’s State Council is talking a big game on controlling inflation. Does it mean China is quickly shifting away from a bias toward export growth toward an inflation fighting bias? That’s the big question. If it does mean that, you can expect lower commodity prices.

For example, three-month copper on the London Metals Exchange fell overnight. The news preceding the drop was that refined copper imports to China fell by a third last month. Comex December copper traded lower too, near $3.75/lb.

We’re going to have Dr. Alex what he thinks about this. But we can guess. He probably loves it. He just got back from another site visit in Africa to a copper project. If you’re a Diggers and Drillers reader don’t worry. You’ve already read about this company. It’s not a new recommendation.

Alex has done his homework on the companies he’s recommended. Weakness in the copper price invariably follows through to the shares. If you’re a secular metals bull, you believe this lowers your average purchase price on the shares most likely to benefit from rising prices.

If you’re a bear on copper, well…you’re a bear. Go dance. Alex, of course, has taken the other fork in the road. This fork is for those who’ve realized the end of the Dollar Standard in the global money system is likely to be bullish for real assets, despite your reflexive US Dollar rallies. Europe’s chronic and structural problems add an element of Dollar support. But the long term story on this fork is to favor "real assets" over paper money.

Which brings us back to Ireland and Australia. Irelands bank’s went all in on the Irish property market. When the bubble burst, the banks were left holding the bag (a huge mortgage book). The bag was so heavy, in fact, it broke their back. So the government had to pick them up. And the bag was too big for the government to pick up too, especially given rising borrowing costs for countries at Europe’s periphery.

Could that ever happen in Australia? Could banks with massive over-exposure to domestic property be caught out by losses and unable to borrow from overseas except at much higher rates? And could the government be forced to step in and cover the bank at the cost of its own good credit?

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Nov 19

Banking Fungus, Inflation Virus

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Contagion risk is everywhere rightnow…

THERE’S A fungus among us. But is itthe banks? Or is it a caterpillar fungus that boosts sex drive and issoaring in price as China imports Ben Bernanke’s inflation virus? asks Dan Denning in his Daily Reckoning Australia.

You didn’t have to know there wasmore trouble coming from Ireland. Just have a pint at any of the pubshere in St. Kilda and you’ll hear a veritable symphony of Irishaccents. Most of the girls are behind the bar serving drinks. Most ofthe boys are at the bar drinking drinks. All of them seem to behaving a pretty good time, even if they are a long way from home.

Meanwhile, back in Ireland, a Europeandrama is playing out. It’s putting pressure on the Euro and justlike back in may, that word “contagion” is being thrown aroundagain. The U.S. dollar is moving ahead while commodities cool off.

But what about the Irish? Thegovernment has a deficit equal to 32% of GDP which it’s rapidlytrying to bring down through spending cuts. And if interest rates onsovereign Irish debt weren’t rising (they are) the governmentdoesn’t appear to be in any kind of immediate funding crisis.

Down the track though, investors arelooking at the Irish banks and realising the Irish banks are stillstuffed with heaps of toxic assets. Irish banks have been borrowingfrom the European Central Bank in order to refinance theirobligations to other lenders. But ultimately, Ireland’s governmentis on the hook for bailing out the banks (again). And if Ireland’sgovernment doesn’t have the money to do it (it doesn’t) then thetask falls to the ECB.

Of course it’s possible the Irishgovernment finally stops the madness and says to its banks, getstuffed. Based on the number of punch ups we’ve seen at pubs in thelast year, we know the Irish aren’t afraid of a fight or a littlerebellion now and then. But the rest of Europe—especially Greece,Spain and Portugal—are keen for Ireland to agree to an ECB plan andhalt an investor run on the euro and on European sovereign debt.

Does any of this really matter toAustralia? Well, aside from expecting even more Irish to invade St.Kilda if the Irish banks fold, the weaker euro is leading to arelatively stronger dollar. That’s causing carry traders whoborrowed in cheap USD to take profits on their “risk” trades inhigher yielding assets like the Aussie dollar, which you can now buyfor ninety six US cents.

Ireland “matters” in the largersense that it’s also a test of popular tolerance for socialisingthe losses of the banks. No one knows what the consequence ofallowing major Irish (or any other) banks to fail. But we are told,mostly by the bankers, that it would be such a disaster for theeconomy that the government simply must assume those bad debts andthe central bank must print more money to recapitalise the banks.

The problem is really the same now asit was two years ago—way too much bad debt that cannot be cancelledout by issuing more debt. The “solution” offered by theauthorities doesn’t really seem like a solution. It just seems likea get out of jail free card for the bankers and endless more debt asfar as the eye can see.

There’s no doubt there’d be somereal havoc in financial markets and the economy with a real reckoningin the banking sector. But the situation we have right now is prettylousy too. Could allowing the banks to fail be much worse? At somepoint the debt is going to have to be liquidated or restructured.

Closer to home here in Australia is thenews that China is trying to choke down inflation by reducing loansto property developers. Bloomberg reports that China’s four biggestbanks–Industrial & Commercial Bank of China Ltd., ChinaConstruction Bank Corp, Bank of China Ltd. and Agricultural Bank ofChina Ltd.—have all met their lending targets this year and won’tbe making any more loans. China’s M2 measure of money supply rose19.3% over the last year, according to figures released last month.

That kind of lending boom leadsto 15-story hotels allegedly being built in six days. Italso leads to politically destabilising inflation in the goods peoplebuy every day. For instance prices in Shenzhen are now growing muchfaster than prices in Hong Kong, which is a reversal of thetraditional relationship. “Shoppers report that certain food andgrocery items can be to 40% cheaper in Hong Kong,” reports ColleenRyan in yesterday’s Australian Financial Review.

“It is not just fresh fruit andvegetables. Even items like Dove soap, which is manufactured in Anhuiprovince in China, is 25% cheaper in Hong Kong…The increase hasbeen more than 300% for a small group of herbs. Caterpillar fungus,said to slow down the ageing process and boost sex drive, has beenone of the top performers.”

The other obvious inflation China is inthe share market. It’s turned down in the last two days, droppingover 4% Tuesday, with metals producers and property developers hitthe hardest. Note also that the Aussie market (the All Ords in thegold line) has pretty much tracked the Shanghai Stock Exchange. TheAussie Dollar looks pretty elevated compared to both.

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Nov 15

This Week on "States in Crisis"

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Ireland, Gold Futures, commodity speculation, and the rest of this week’s news – in advance…!

THIS WEEK’s episode of “The WelfareState in Crisis” features a guest appearance by the Emerald Isle,currently seeking about $110 billion in bailout money from theEuropean Union, writes Dan Denning in his Daily Reckoning Australia.

Actually, Ireland is not seeking that money, and that appears to be a part of the problem. The Irishgovernment is content that it’s managing its problems well,independent of European meddling.

But with 10-year Irish bond yieldsblowing out to a spread of 646 basis points over 10-year German debtlast week, European officials are worried that problems in Irelandare problems for the Euro. And if problems for the Euro get worse,that means problems for Portugal and Spain too.

No wonder the US Dollar quit fallinglast week. And no wonder commodities fell like a stone. Friday was anugly day for commodities speculators. The CRB Index in New York fell3.6%. Every single one of its 19 components was down. Sugar contractsfell 12% in London and corn and soybeans traded limit down.

Part of the shocking action incommodities futures markets is the raising of margin requirements byexchanges. It happened in silver last week. And it happened for sugartoo, when the ICE futures boosted margins on sugar contracts by 81%to shake out speculators. It will probably happen on Gold Futurestoo, and that might explain the $40 thud last Friday, among otherthings.

No one is forced to speculate, ofcourse. But this is what the Bernanke Fed has wrought. ItsQuantitative Easing action has put dollar owners in the position ofdoing nothing and losing money to inflation, or speculating intangible assets that go up in price relative to the dollar. And it’s not just commodities. It’s currencies too.

The G-20 summit in Seoul failed toproduce any result on competitive currency devaluations. No onereally expected it to. But what’s next? Since there is no quick andeasy solution to replacing a broken world currency system, the slow,difficult, and ugly scenario must take place. It will probably beslow, difficult, and ugly.

One thing you should expect more of isan escalating level of capital controls. Ironically, the firstmanifestation of this has been in export-oriented economies likeBrazil, where the government tripled a tax on foreign investment inlocal bonds from 2% to 6%. It was designed to prevent furtherappreciation in Brazil’s currency, which yields over 10% and is up35% in trade-weighted terms since last year.

China, South Korea and other countriesare taking similar measures. For big exporters, a stronger currencytranslates into a loss of competitiveness. And when capital marketsare wide open and you find yourself on the receiving end of hugeinflows, it can lead to rapid asset price appreciation and otherforms of less desirable inflation.

By the way, this shows you how everyoneis complicit in trying to return to the status quo ante GFC. Theexport-driven BRIICs want to pretend that the credit-financed Welfarestates don’t have real structural deficit and demographic issuesthat prevent a return to “normal” rates of consumption. They wantthe world be the way it was.

Here in Australia, other than houseprices being utterly unaffordable, it looks like things have neverbeen better. The rising Aussie dollar (up 17% since the end of Junealone) helps “contain” some of the inflation from booming coaland iron ore exports. That’s why the Reserve Bank of Australia isone of the only central banks in the world that does not appear to beactively trying to weaken its currency.

Maybe the RBA agrees with Bloombergthat on a purchasing power parity basis, the Aussie is trading at a30% premium to fair value. That makes it the most over-valuedcurrency in the world at the moment. If it’s a short-term trade(instead of long-term or secular trend in which the Aussie surpassesthe USD), the currency will weaken and not do any permanent damage toAustralia’s own export competitiveness by making Aussie exportsmore expensive than alternatives from Africa.

For now, the Aussie is the placeeveryone wants to be as well; a high-yield commodity currency from acountry with comparatively low public sector debt (although highhousehold debt), low unemployment, and economic growth correlated toAsia. What could possible go wrong when things can’t’ get anybetter?

Speaking of Asia, the other non-Irishnews that rocked commodity markets last week was that China againraised reserve requirements at key banks and may raise interest ratesto ward off inflation being poured into China from the U.S. Stocksand commodities fell hard.

What do you make of all this mess?

To us, it means that anxiety about theAussie being too strong for too long may be short-lived. China couldbe doing a dress-rehearsal for a much more dramatic fall in assetprices as the authorities try to prevent inflation from surging. Thishas obvious and bearish implications for commodity prices.

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Nov 08

Casino Inflation in Junior Stocks

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QEII makes a casino of investing. Place your bets…!

SO WHAT IF the Fed pushes short-term yields so low on US notes and bonds that it forces everyone else to takes heaps of risks and buy stocks and commodities? asks Dan Denning in his Daily Reckoning Australia.

That is the question that kept us tossing and turning Sunday night. By monetizing so much of the debt at the shorter end of the US yield curve (note and bonds that mature in 10 years or less) the Fed makes those instruments extremely unattractive to anyone who wants a return that beats inflation.

And in point of fact, yields on two-, five- and 10-year notes are all at or near record lows. Prices go up a bit, but not really enough to make buying US debt a winning trade. That means investors have to go out and buy junk bonds, or corporate bonds, or emerging market bonds. Or equities. Ahh, yes. Equities.

Perhaps that is why the stock market went up on the QE announcement last week. The size of the Fed’s move wasn’t a big surprise. But perhaps the dynamics of its movement – crowding everyone else out of the short-end of the bond market – is setting off the hunt for other assets…and stocks are an easy option. This is why stocks could make new nominal highs without any real improvement in the earnings prospects for major companies (ex financial).

Meanwhile, in the derivatives market, Gold Futures were knocking on the door of US$1400 per ounce, about to kick down the door. We’re here in Sydney to talk about gold to the Gold Symposium on Tuesday. The easy thing to do now is make a price forecast. Goldman Sachs did that last week, setting a price target of $1,650 for gold in the medium term. But all the action in the precious metals is pretty bullish right now, including silver, platinum, and palladium. And we mentioned on Friday that some analysts are even saying the base metals will thrive in the QE II trade, with some copper forecasts hitting $12,000 per tonne.

Reuters reported on Friday that copper hit a 27-month high, just a couple of hundred Dollars off its all-time high on the London Metals Exchange. It was a kind of delayed reaction to Wednesday’s Fed news. First, a possible strike at a major mine in Chile clouded the supply picture. But really, it’s as if everyone started to think the same thing at exactly the same time: Inflation!

The fact is that each phase of global financial crisis has been met with a money flood from the authorities. That money usually (and first) finds its way into the share market, and it takes the small fry up fastest. To me, this is the definition of financial gambling. That is, the Fed is turning the entire global stock market into a casino. It’s also probably accelerating the flow of capital out of Dollar denominated assets and into other markets with less destructive central bankers and politicians. That said, it could be bullish for tangible assets and thus, junior resources.

Says Barron’s magazine:

"This year, for the first time ever, China has been investing more overseas in assets like iron, oil and copper than it puts into US government bonds. China in this year’s first half spent $31 billion on hard assets, compared with $23 billion on Treasuries and other US government bonds. Experts say China’s investments in each of these asset classes will total about $55 billion for the full year. But even a tie marks a major turnaround from China’s previous practices."

So yes. That seems all very bullish and favorable for Aussie stocks. Almost too good to be true, though. The devaluation of the Dollar isn’t likely to be so easy to profit from. And it’s probably going to get a lot more political.

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Nov 04

Après le Fed, the Deluge

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$100 billion here…$900 billion there…and none of it real money…

AND NOW, the deluge. Or should we call it the Torrent Signal that our mate Kris Sayce has been banging on about for the last week? asks Dan Denning in his Daily Reckoning Australia.

That’s right – that gushing, gurgling, sputtering, splurging sound you hear is the sound of hundreds of billions of new US Dollars flooding into the economy and the stock market. Over the next eight months, the Federal Reserve will spend an additional $600 billion it doesn’t have buying US bonds in the name of "price stability".

If Kris is right, price stability is the last thing you’ll see at the small-cap end of town in resource-rich Australia. For a variety of reasons, Fed policy doesn’t seem to just trickle down into the small caps and junior Gold Mining and resource sectors. It rages on through like Old Man River.

All up, the Fed is going to chuck in about $100 billion a month into the market. It said more large-scale asset purchases were possible if inflation was too low or unemployment too high. Remember, the Fed has a dual mandate of price stability and full employment. These days, price stability apparently means creating enough money to support asset prices, lest they crash.

Even though we’ve said it before, it’s worth repeating: Everything the Fed does these days is designed to support US banks. Monetizing US government debt doesn’t do a lick of a good to improve the quality of the assets on US bank balance sheets. The Fed is merely trying to keep interest rates from spiking; an event which would send even more banks into terminal decline because of its affect on the housing market (which is already in serious trouble) and would put households in further defensive mode.

As far as the stock market is concerned, there are a lot of green numbers on the screen this morning. Because this $600 billion announcement was in the Goldilocks spot – not too large, not too small…just big enough to please the market without being so big it scared anyone about how inflationary it really is.

Please note that the Aussie Dollar moved above parity on the Fed move and stayed there. Is parity the new normal for the Aussie? Maybe. Speaking for ourselves, we’ve been waiting for a big correction in silver and gold to add to our precious metals holdings. But it just hasn’t come yet.

What could this mean? It could mean that the inter-market relationships that seemed to govern the movement of the Aussie Dollar, the US Dollar, and precious metals prices are breaking down. The greenback is getting weaker relative to everything else. The Fed contributes to this with its march to restore monetary insanity. Two years of grid-locked Washington dealing with a fiscal nightmare probably add fuel to the Dollar’s fire.

By the way, the real amount of QE, when you add in the Fed rolling over mortgage purchases, is closer to $900 billion. That’s almost enough to start a new war. But what’s a few hundred billion here and there when it’s not real money anyway?

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Nov 01

Financial Extremists

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Financialization has led to a world of useless analysts and "extremist" naysayers…

OH WOULD the International Monetary Fund please shut up and leave Australia alone? asks Dan Denning in his Daily Reckoning Australia.

According to a report in The Age, the IMF is about to release a report in which it reveals that Australian house prices are "moderately" overvalued by 15%. This is not nearly extreme enough, in our view…which makes us an "extremist" to use the words of our friend Rory Robertson, with whom we debated about house prices a few months ago.

Rory used the word like it was a bad thing, which, we suppose, it IS, when you’re using about people who blow things up for religious reasons (probably the image/impression he wanted to conjure). But we’ll let you in on a little secret…

When asset prices become unhinged from values – as they do in a worldwide credit boom – the world has become an extreme place. Extreme asset values are the rule and not the exception during a credit boom.

We are all extremists now, Rory. Because the Fed has forced us to be.

Incidentally, this is why returns on most asset classes are so tightly correlated during a crack up boom. There’s no point in differentiating between what’s cheap and what’s dear when everything goes up. Thus, bad credit (or too much credit) clouds good judgment.

To follow up on this thought, this explains how too much credit perverted Wall Street. Yes, the money was easy which probably lowered the threshold for committing fraud on a mass scale (subprime mortgage lending and securitisation). But if credit elevates asset values, then there is no need to an analyst anymore. You can’t distinguish yourself by virtue of the quality of your work. In fact, the quality of your work has less and less influence over the result, which is foreordained because of the flow of money into markets. This is why Wall Street (and America, and a lot of the Western world) have moved from a culture of merit-based achievement to a culture of "who can legally loot the most money."

This gradual corruption of the value of honest work and honest money is the result of the financialization of our economies. We’d argue that it all stems from the corruption of our money (fiat money). When the basic unit of value and of conducting transactions for goods and services becomes unreliable, unstable, and is designed to erode over time, is it any surprise that other values erode too?

Gold, which as a noble metal does not rust (or erode), is currently trading at US$1341. Everyone is wondering what the Fed will say next week. Everyone is expecting "the big one". But as our colleague Murray Dawes notes, the Fed is probably going to drip-feed support markets (through large-scale asset purchases) on an as-needed basis. This month could be a big fat nothing-burger if you’re expecting…a big fat policy announcement.

Or, in narcotic terms, the markets are looking for their next big hit. They are already nervous that if the Fed doesn’t bring more liquidity (smack) the big indexes will correct (come down) to reflect how they have mis-priced the Fed’s actual efforts. The Fed has left everyone guessing, but generally buying, which is probably what it wanted.

For our money, and probably because we just wrapped the October issue of Australian Wealth Gameplan (AWG) in which we wrote about the matter extensively, the real game changer in the world currency scene will come from the slowly but inexorably imploding US mortgage market. The recapitalization of US banks and improving their earnings is the real target of the Fed’s Dollar devaluation policy – which makes perfect sense when you recall that the Fed is a cartel of those very same banks. Of course it would act to save its member banks, even if it cost US taxpayers hundreds of billions and a real loss in American standards of living as a result of the end of the Dollar standard and lower US purchasing power.

Australia seems to be perfectly positioned for Dollar devaluation to the extent that it’s a commodity producer (commodities are priced in Dollars and thus growing in value as the supply of Dollars increases). It doesn’t hurt that Australia – like Singapore and Malaysia – is also a kind of China-proxy.

That is, those currently exiting the Dollar may be looking for a currency with a chance of growing in purchasing power. That would be China’s currency – if and when it ever lets that happen. This is also an issue we covered in the AWG report. But if you can’t buy Chinese assets or own Chinese currency directly because of capital controls, you have to do the next best thing.

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Sep 30

Gold Jilts Oil

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Might you miss the biggest stories by watching gold too closely…?

So the TWO BIGGEST members of the former Communist/Red/Central Planning club yesterday finalized a deal yesterday to send 300,000 barrels a day of Russian oil to the Chinese city of Daqing for the next twenty years, writes Dan Denning in his Daily Reckoning Australia.

It’s a $26 billion loan-for-oil agreement that comes with an actual oil pipeline between eastern Siberia and north-east China. So why wasn’t this story front page news? Because gold is making new highs and oil is not, that’s why.

Oil is a jilted commodity at the moment. Traders remember what it did to them in 2008 after the bubble popped. But if you’re a contrarian, you want to pay attention to the stories that are not making headlines. Hence, oil.

But like everyone else trying to get ahead of the game, we’d rather focus on gold. Late last night, wide awake from the jet lag, we puzzled over whether now is the right time to Buy Gold in Australia (and whether coins and/or bullion and/or shares). The strong Australian Dollar mentioned yesterday has capped gold’s rise when denominated in Aussies. And should 2008 repeat itself in some way, the USD would rally against the Aussie…and the Aussie Gold Price should approach its high of just over A$1,500.

But will that happen? It’s a known unknown. If you haven’t sorted out whether gold shares or Gold Coins or Gold Bullion should be part of your investment strategy, you still have time to think about it and do something, if that’s what you decide. One reason you have time is that one of the strength’s of gold’s current move is that central banks are buying it instead of selling it.

This was something we mentioned in our remarks at the Gold Standard Institute show last year; the remonetization of gold in the world’s financial system. In fact, in January of 2009 we wrote the following:

"It’s not rash speculation to suggest that central banks will prefer to hold on to their gold this year – rather like the increasing (if small) number of private individuals – instead of selling it. As competitive currency devaluations sweep the globe in an all-out effort to fight asset deflation and recession, we think gold will become much more desirable as a reserve asset worth owning, not selling for cash."

Fast forward to Sept. 2010, and "European Central Banks Halt Gold Sales," reports the Financial Times. The article referred to the European Central Gold Bank Agreement (the same agreement we discussed in 2009). That agreement was designed to control the amount of gold being sold onto the market by European central banks. The ceiling for annual sales between September of 2009 and September of 2010 was 400 tonnes of gold.

Last year’s agreement expired last week. But Europe’s central banks sold only 6.2 tonnes of their gold. Sales fell by 92% from last year. Banks know what real money is. And they’re not selling their gold anymore. They’re buying it.

Maybe central bankers are Buying Gold because their respective finance ministers are actively trashing local cash. "We’re in the midst of an international currency war, a general weakening of currency," says Brazil’s Finance Minister Guido Mantega. Exporting nations are trying to boost competitiveness by keeping their currencies cheap and the price of their exports low.

It’s a strange old world when you improve your economic strength by weakening your currency. Japan and other Asian exporters (dependant on credit-financed consumption in North America) have been doing it for years. But maybe not everyone got the memo from the stock market in 2008 than the global credit bubble has popped.

You have to wonder if the strong Aussie Dollar will hurt the competitiveness of Aussie exporters. It will probably hurt some a lot more than others. By "others" we mean commodity exporters. For now, any rebound in global mining investment has not led to a huge new production increases in the key commodities produced by Australia (iron ore and coal). The strong Dollar isn’t hurting a bit.

But Chris Richardson from Access Economics warns us not to take the high terms of trade and commodity boom for granted. "Australia’s fiscal finances, both short and long term, are hostage to the fate of commodity prices, and hence to China’s strength,’" he recently wrote. He added that Australia’s Federal budget depends on high commodity prices to end the deficit.

"The return to surplus trumpeted in the official forecasts is a pure punt that China and India will keep growing faster than the world’s miners will keep digging deeper," Richardson says. "The budget used to be stodgy and boring and responding to a whole range of economic indicators. Now its health or otherwise is very narrowly based on coal or iron ore prices, and that’s a very fickle thing to rely on for fiscal health."

Yes it is.

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Aug 19

Goldman’s Gold

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Interesting article on Goldman and Gold.

Goldman Sachs is bullish on Gold Prices. Reason to worry…?

If GOLDMAN SACHS is publicly bullish on gold, is that a good thing or bad thing for gold bulls? asks Dan Denning in his Daily Reckoning Australia.

Wall Street’s notorious trading house published a report on gold last week setting a price target of US$1300 in the next six months. The report cited several factors. But before we get into them, we’ll confess it made us a bit nervous. Whenever a broker is saying one thing, you have to wonder if they’re actually doing the opposite.

That said, Goldman did make a point that is true of an asset in a bull market: it requires corrections to shake out the speculators and weak hands from time to time. Following the June high north of $1250 the net speculative long positions declined. Traders took profits. And so did momentum players in the exchange traded funds market.

But then something happened that naysayers such as Michael Pascoe and Rory Robertson did not expect. The gold bubble did not pop. Because it’s not a bubble. The momentum players departed and the price found plenty of support. It’s now around US$1220.

Goldman says the big catalyst for a further move higher (other than its announcement leading to a stampede of money into gold short-term) is a repricing of US growth expectations for the rest of this year and all of next. Maybe it’s a fear trade, or just bearishness on US corporate profits when unemployment keeps rising.

Either way, about the only dubious chart we saw in the whole report is the one showing lower US real interest rates and the Gold Price (exhibit five). As those cool cats in statistics say, correlation is not causation. Its possible low rates give speculators fuel to play in the gold market. But it’s more likely, we reckon, that US rates are low because the bond market is pricing in a deflationary scenario.

So why would gold rise in a deflationary scenario? Good question! It brings us full circle to the argument fund-manager David Einhorn made when we announced his gold position: you Buy Gold when you think monetary and fiscal policy are bad (we’re paraphrasing). Whether it’s inflation or deflation matters less than the fact that something unconventional and bad is going down. Gold does well in that environment, what with it being real money and all.

Take a look at the Aussie Gold Price chart below. It shows you that gold is much closer to making a new high in US Dollar terms than it is in Aussie Dollar terms. For Aussie gold to match the greenback gain, you’d need a much stronger greenback or a much weaker Aussie. It’s worth noting that following the Fed’s announcement that it would sort of begin quantitative easing part two, the Aussie made the second-largest declines against the greenback, trailing only the dreaded Esperanto currency, the Euro…

As we have banged on about gold for years now, we won’t test your patience much longer. But last week’s news that the Aussie unemployment went rate up in July wouldn’t be Aussie Dollar bullish, would it?

Maybe the Aussie will get a boost when this miserable Federal election nonsense is over. When thinking about the election we recall the phrase, “Don’t vote! It only encourages them.” Of course voting in Australia is compulsory. But it might be a fine worth copping if you can say you weren’t an accessory to “the advanced auction of stolen goods,” as Mark Twain once put it.

Seriously. If anything is clear so far about the difference between the two major parties, it’s that both treat Australians as chattel. We are but tax slaves who exist to fund the government’s spending pleasures. And the Greens? More like the Reds!

But that’s all politics. Financial independence is the only real defense against this kind of relentless State encroachment from all sides. Get it. Keep it. Defend it. And whether you like it or not, more and more governments across the world are spending out of an empty pocket. They’re spending to give people money that’ve lost jobs as a result of the structural shift in the labor markets. That shift came from globalization. The money might keep people above water for awhile, but it’s no replacement for a real job making real things.

More and more spending is going to simply pay the interest on previously borrowed money. This is probably the most dangerous aspect of a credit bubble. You borrow and spend all that money and, and the end of the day, you have nothing to show for it…no bridges…no roads…no factories…no real increase in the capital stock. Just a lot of over-priced residential housing that suddenly isn’t in such short supply as you thought. And now Australia finds itself at an interesting crossroads.

Just a little debt didn’t seem like such a bad idea at the height of the global financial crisis. Both Australia’s major political parties now promise to pay it off quickly, with all the bounty from mineral and energy royalties. Both will increase spending too, but in different places, cutting other spending priorities.

But should the housing bubble pop sooner rather than later, and should Aussie banks find themselves last in the queue for global capital in another phase of the Great Correction, the temptation for more government borrowing will be nigh irresistible.

Why? Well, our stance against government debt may seem dogmatic. But if it is, it’s because the modern State always abuses the power to borrow. Always. Whether it’s to fund politically popular but economically unproductive projects, or whether it’ just a way of putting off tough choices about actually reducing government spending and, thus, the reach of the State into private life, it’s always easier to borrow and kick the can down the road.

Debt is the health of the State in the same way that liquor is the health of the alcoholic. The relationship is inherently destructive. But we reckon that in the face of so much unproductive debt (household and sovereign) the only politically palatable policy response will be to monetise that debt: pay it off or buy it from bank with new money. The deflationists can enjoy their moment in the sun while it lasts. But it won’t last for long at this rate.

Buying Gold today? “If there’s an easier way, I’ve yet to find it,” says one BullionVault user…

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