Posted by: L | July 24, 2007

Goldilocks and the Dollar bear..

With all the rah-rahing by analysts over the stock market’s performance, more attention needs to go to the stealth implosion of the dollar in the last couple of weeks — and the resurgence of gold prices. While the MSM and the money professionals try to frame the Bear Stearns mess (2 of its hedge funds were wiped out and a third returned 91% losses) as an isolated event, the shock waves are hitting the credit market as supposedly triple-A bonds are suddenly being rechristened junk..

This looks like the end of a long period of financialization that started a while back..maybe even a decade ago… but while it might not be curtains yet, it’s time to look at your savings in dollars and dollar-denominated assets and figure out how you plan to stop them from being wiped out by currency devaluation:

A good piece about that by Ambrose Evans Pritchard in the Telegraph,

When Will Gold Go Ballistic? (read the informative responses here)

which avoids a hard sell on gold, while staying optimistic about its long term prospects.. .
“Here we go:

I started buying gold mining shares in September 2001, missing the bottom by four months. I still hold some shares (mostly duds, since I am the village idiot when it comes to picking stocks). Gold’s 15 to 20 year upward cycle is alive and well.

For those who don’t follow bullion, gold hit $252 an ounce in the Spring of 2001 in a final capitulation sell-off when Gordon Brown began his Treasury sales. It rose to a peak of $730 in May 2006.

Gold has languished since, in part because of sales by the Spanish and Belgian central banks. I remain very wary in the short to medium-term.

What unnerves me is the way gold has tended to move in sympathy with global stock markets. Whenever risk appetite rises, it rises. When investors shun risk, it falls. In other words, it has become correlated with all the speculative trades – notably the yen and franc carry trades – responding to abundant global liquidity. This liquidity is now being drained as the BoJ, ECB, SNB, BoE, Riksbank, and Chinese Central Bank, etc, turn off the tap. So be careful.

While the pattern appears to have changed over the last couple of weeks, this is not long enough to establish a “paradigm change”, excuse the ghastly term. My concern is that gold will fall hard along with everything else (except the yen and the Swissie) in any market crash/correction.

At some point it will decouple, as it did during the 1987 crash when it fell hard, found a ledge, and then recovered hard, while the DOW kept falling. But, I would rather hold Swissies or Yen until gold finds that ledge in a downturn, resuming its old role as a safe store of value. This may happen quite quickly in a crisis. (Of course, I may also be left behind right now in an accelerating rally, but that is a risk I accept)

Ultimately, gold will surge, once it becomes clear that the euro lacks the staying power to serve as an alternative to the dollar. To restate a point I have made many times, the euro-zone is an ill-assorted mix of 13 unconverged national economies – with national treasuries, debt structures, taxes, pensions, and labour laws – that are not ready to share a currency, and are drifting further apart by the day.

(Lest anybody forgets, the motive behind monetary union was PURELY political. The economists at the European Commission warned that the project could not survive over time if it included a Latin Bloc of countries with an unreformed culture of high inflation, rising wage costs, and an export base exposed to Asian competition [unlike Germany’s, which is complimentary] – unless it were backed by a full superstate. They were ignored. Indeed, any future crisis was to be welcomed as the “beneficial crisis”, a chance to force through full political integration that would otherwise have not been possible, as Romano Prodi so candidly admitted when he was Commission chief).

At some point it will become clear to everybody that: the Club Med group cannot compete at an exchange rate of $1.40, $1.45, $1.50, or whatever it reaches; their credit booms are tipping over; they will soon need stimulus more than the US.

Goldman Sachs, by the way, is already ‘shorting’ Italian and French bonds, while going ‘long’ on German bunds to play the divergence (the opposite of the euro-zone ‘convergence play’ that made the banks rich in the 1990s).

We may have a situation where sharp dollar falls caused by impending rate cuts by the Fed sets off a systemic crisis for Euroland. If so, politics will quickly take over from economics and begin to dictate events in Europe. The ECB will have to stop raising rates (whatever Berlin wants), and the euro will become a structurally weak currency tilted to the need of the weakest players. If it doesn’t, the EU itself will blow up. So the ECB will have to change tack to support the union. And the European Court will interpret the treaties in such a way as to force the ECB to do so.

Gold will fly once investors can see that neither of the two reserve currency pillars (euro and dollar) is on a sound foundation, and once the pair are engaged in a beggar-thy-neighbour devaluation contest to stave off a slump (if necessary with the use of Ben Bernanke’s helicopters, meaning mass purchase of Treasuries, mortgage bonds, stocks, or assets of any kind to support the markets). This would amount to a partial breakdown of the monetary system. Gold will not stop at $800. It might well go beyond $2,000.

We are not there yet. Timing is not my forté, but 2008 looks ripe. Watch the Spanish housing market. Watch the French trade data. Watch Chinese inflation. And, of course, watch the US jobs market – the bogus prop to the alleged US recovery (on that, more later).”


Well — gold was a bit uncoupled from the dollar index for quite a while, but the technical action over the last few weeks certainly hasn’t been. Gold is once again up when the dollar is down now, and it probably reflects credit anxieties spilling over from the sub-prime mess in the housing market.

(Translation for those who haven’t been following the housing market recently: subprime loans are those substandard loans that used to represent only a miniscule proportion of the housing market but in the last 3-4 years rose to lethal levels. It wasn’t just that the borrowers hadn’t the proper credit history; the lenders were leveraged to the hilt. The lenders, mind you, not being your friendly bank on the corner any more, nor the government-backed lenders like Fannie Mae and Freddie Mac but a whole plethora of con men in financial fancy dress. These hedge funds and bankers sold their clients substandard mortgage- backed financial securities (MBSs) disguised as gilt-edged investments, which are now blowing up in their faces like hand grenades, as the borrowers find themselves unable to meet their house payments. Why? Because the terms are tightening up — as they tend to do in subprime mortgages…..

Used to be called loan sharking in the old days.

And Pritchard may also be right about the Yen being a safer bet for diversification than the Euro — a faux currency, if ever there was one.



  1. […] Clark Link to Article gordon brown Goldilocks and the Dollar bear.. » Posted at LILA RAJIVA: The […]

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