The Gold Standard for Week Ending 16 Jan. 2005
by Mark O'Byrne. January 19, 2005
Weekly Market Commentary
Gold (+0.86%), Silver (+2.65%), Commodities, represented by the Reuters CRB Index (+1.5%) and Oil (6.73%) were all up for the week. Nymex Sweet Crude's price surge was massive and worrying. Gold, silver, oil and the commodity complex look to be consolidating at these levels before attempting to take out their recent highs. However, their may be further short term weakness before their long term trends reassert themselves. We believe all commodities are in the early stages of multi year bull markets akin to those of the 70's. We believe this to be particularly the case with gold and silver as they are not only commodities and debt free, hard tangible assets but they are also currency or monetary assets.
The US$, Currency, Stock and Bond Markets were all remarkably sanguine and strangely witnessed very little movement whatsoever despite the surging oil price and the unprecedented and record Trade Deficit. We remain bearish on the US$ but believe there is a possibility of a short term rally from these levels however due to the unsustainable fundamentals of the US economy with the record Trade Deficit, Current Account Deficit and Budget Deficit, not to mention the record Debt to GDP ratio of more than 305%, we believe the long term trend of the US$ is down against nearly all currencies and tangible assets. This will make assets priced in US$'s, such as US stocks and bonds, to become less attractive to both non-US and US investors and savers. And the triple deficits will also definitely impact negatively on the US stock and bond markets. The question is no longer if stocks and bonds will fall in value (causing interest rates to rise further negatively affecting the wider economy) rather when this inevitable correction happens.
Thus, we believe the trade of the decade (and probably the early part of the next decade) is to invest in debt free, hard tangible assets which are commodities but also increasingly being viewed as attractive alternatives to currencies.
Market Prices and Price Changes
US Trade Deficit
The week was dominated by the all time record high monthly US Trade Deficit of US$60.3 Billion for November. The October deficit was $56 Billion and thus there was an increase of 7.7% in just one month. Analysts had expected the deficits to decline due to lower oil prices in the month but the US' insatiable appetite for foreign oil and even imported food reached record levels. U.S. exports, which had been rising for much of the year, suffered a setback in November, falling 2.3 percent to $95.6 billion, reflecting widespread declines in sales of all sectors.
The deficit through November totalled US$561.3 billion and is expected to top US$600 billion once December's figures are tallied, far surpassing last year's record of US$496.5 billion.
The US government had expected and hoped that the decline in the price of the dollar against some currencies would boost exports and curtail US consumers purchasing of imports. This has not happened and means that the price of the dollar will have to go significantly lower in order to correct these massive and unsustainable imbalances. This will decrease the attractiveness of US equity markets which are denominated in US$'s, on the US bond markets. Any sustained selling of US Treasuries and bonds will lead to higher interest rates which may have implications for the already overly indebted US consumer and for the highly leveraged US mortgage market.
Oil Prices Surged to $48.38 or 6.73% (Nymex light sweet crude) a barrel on demand and supply worries.
Cold weather may boost U.S. demand and the severe storms experienced and throughout Europe over the weekend were particularly vicious in the North Sea, affecting production fields both helped drive up prices.
This comes against a backdrop of continuing and significant increases in demand for oil, commodities and precious metals from the developing world and emerging markets such as Brazil, Russia, Eastern European countries, Central and South East Asian countries and especially India and China. The Chinese, for example announced just this week that their imports of crude oil had increased 35% in just one year. This is a huge increase and a significant portion of world supply as China is already the world's second-biggest oil consumer after the US.
Iraqi supplies have been disrupted again. The Iraqi Oil Minister warned the attacks were not random but part of a deliberate strategy to create fuel shortages in the capital. Ghadban said attacks numbered more than 200 in 2004 and had averaged about 24 per month. "There is a leadership running these terrorist attacks. That leadership has maps and is aiming to isolate the city of Baghdad," Ghadban said.
The problems in Iraq are part of the wider geopolitical problems of the Middle East. The occupation of Iraq is now added to many of the Arab peoples already deep distrust of US foreign and economic policies due to what they perceive as the US' bias towards Israel and the US' support of undemocratic regimes in Saudi Arabia, Egypt, Pakistan and elsewhere.
It seems as if the Bush Administration have decided that attack is the best form of defence and only this week there have been calls by some Neo-Con hardliners to widen the conflict by bombing what they term "insurgent training camps" in that other member of the 'Axis of Evil' Syria. Over the weekend, intelligence officials have said that US commandos are already hunting for secret nuclear and chemical weapons sites and other targets in Iran, and have a plan to turn this other powerful member of the 'Axis of Evil' into the next front in the war on terrorism.
This can only foster deeper resentment and anger and create even greater instability in the region going forward which means the days of oil below $40 barrel are unlikely to be seen again.
Brand America and the Trade Deficit
US foreign policy in the region is not only alienating moderate opinion in the Arab world and indeed alienating Arab elites traditionally sympathetic to the US it is also greatly affecting the rest of the world's view of the US. A recent survey of 8,000 international consumers, carried out by the Seattle-based an independent market research company, Global Market Insite (GMI) Inc. http://www.gmi-mr.com/en/index.phtml., found that on top of the human and financial costs of the war in Iraq, the Bush administration's foreign policy may be costing U.S. corporations business overseas. It found that that more than two-thirds of European and Canadian consumers have had a negative change in their view of the United States as a result of US foreign policy over the past three years. One-third of all consumers in Canada, China, France, Germany, Japan, Russia, and the United Kingdom said that U.S. foreign policy, particularly the "war on terror" and the occupation of Iraq, constituted their strongest impression of the United States. Brands closely identified with the U.S., such as Marlboro cigarettes, America Online (AOL), McDonald's, American Airlines, and Exxon-Mobil, are particularly at risk.
Kevin Roberts, chief executive of advertising giant Saatchi & Saatchi, told the Financial Times that he believed consumers in Europe and Asia are becoming increasingly resistant to having "brand America rammed down their throats." Simon Anholt, author of ?Brand America?, has also predicted a consumer backlash against U.S. foreign policy. He recently told the British trade magazine Marketing Week that four more years of Bush's foreign policy could have grave consequences for U.S. companies' international market share.
Nearly half believed that the war in Iraq was motivated by a desire to control oil supplies, while only 15% believed it was related to terrorism. Nearly two-thirds of European and Canadian consumers also said they believed U.S. foreign policy is guided primarily by self-interest and empire-building, while only 17% believed that the defense of freedom and democracy is its guiding principle. Half of the entire sample said they distrusted U.S. companies, at least in part because of U.S. foreign policy. Seventy-nine percent said they distrusted the U.S. government for the same reason, while 39% said they distrusted the American public.
"There have already been casual protest brands, such as Mecca Cola, which are primarily political," he told the weekly. "But things are now moving beyond that. For instance, German restaurants are beginning to refuse American Express cards. This is new territory."
This does not bode well for the US Trade Deficit. How can the US possibly reduce their deficit if an increasing majority of the consumers in the western world are wary of US brands and goods? The answer is with grave difficulty.
China and US tension, the Yuan, the Dollar and the US' Twin Deficits
A congressionally mandated commission reported yesterday that China's growing trade surplus with the U.S. has cost 1.5 million U.S. jobs since 1989. Lawmakers and manufacturers are also urging China's government to curb subsidies and clamp down on counterfeiting of trademarked goods.
"When China's leaders fail to produce results on the points of friction in our trading relationship, their failure only empowers those critics within the U.S. political system," Commerce Secretary Donald Evans said today in a speech to the American Chamber of Commerce in Beijing.
The U.S. is pressing China to change the yuan's decade-old peg of about 8.3 to the dollar, saying the fixed rate depresses the yuan's value, giving Chinese manufacturers an unfair advantage by making their goods cheaper abroad. The view was repeated earlier on Thursday by U.S. Commerce Secretary Don Evans, in an interview with Reuters. However, HSBC's chief economist, Stephen King said on Thursday "solving the massive U.S. current account deficit does not hinge on a revaluation of China's yuan currency but on the ability of Americans to boost savings. The reason for the misalignment, particularly in terms of the current account balance, has very little to do with the value of the reminbi at all as King said China comprised less than a tenth of the dollar's trade weighted basket.
"So let's say that the renminbi will revalue by 20 percent, that would mean a fall in the dollar's trade-weighted exchange rate of only 2 percent," he said, noting the trade deficit had widened in the past two years despite a 20 percent fall in the dollar on a trade weighted basis.
"The current account deficit exists primarily because of the lack of U.S. savings and that needs to be addressed," he said. The U.S. personal savings rate -- or proportion of money U.S. workers save from disposable incomes -- has been falling for the past two decades. The slide has been particularly severe since 1995, with it falling from about 6 percent to near zero now.
Some analysts say the demand from Asian central banks to park their dollar surpluses in U.S. Treasuries has allowed Americans to spend despite the collapse in savings. Foreign holdings of Treasuries rose about $216 billion in 2004. Asian central banks increased foreign currency reserves last year by around $500 billion and parked much of it in U.S. debt.
Essential Reading from the Week
Warren Buffett, Dollar Bear - Forbes, 14-01-04 Euro being considered as a reserve currency of the future: HSBC - Reuters, 14-01-05 Study sees rivals to US power - Boston Globe, 14-01-05 India, China to be global giants - Rediff, 14-01-05 ECB worried about property price bubble - RTE Business, 13-01-05 US Trade Deficit Rises to New High; More Risk to Dollar - New York Times, 13-01-05 US Deficit hits 'Grand Canyon level' - Sydney Morning Herald, 13-01-05 Oil Creeps Towards $47 on Supply Concerns - Reuters, 13-01-05 Official data add to signs of cooling housing market - FT, 11-01-05 U.K. Retailers Had Worst December in Over a Decade - Bloomberg, 11-01-05 World economic conference putting focus on US deficits - Boston Globe, 10-01-05 Essential Quotes from the Week
"In the end, denial is usually the only thing left. In my view, that's pretty much the case today in world financial markets. Imbalances on the real side of the global economy have moved to once unfathomable extremes. And now the Federal Reserve belatedly enters the fray threatening to take away the proverbial punch bowl from a rip-roaring party. Financial markets hardly seem concerned over this impending collision. Spreads on most risky assets have fallen to razor-thin margins. Steeped in denial, investors have once again become true believers in the sure-thing syndrome."
There can be no mistaking the absence of risk aversion in most segments of world financial markets.
Stephen Roach, Morgan Stanley, 12-01-05 Senior Deputy Governor Paul Jenkins suggested international investors could cool off lending to the United States if its ?massive current account deficit with the rest of the world? continues... ?The United States is running a large fiscal deficit, which is reflected in a massive current account deficit with the rest of the world,? The United States had to borrow an amount equivalent to 5.5% of its GDP each year to support U.S. consumption. ?So far, international investors have been willing to continue to lend to the United States.
But this situation is simply not sustainable: no economy can continue to pile up current account deficits of that size forever, especially if these deficits represent current consumption rather than investment which would increase the economy?s production capacity.?
"We now have the Grand Canyon of trade deficits," said Joel Naroff, head of Holland, Pennsylvania, a forecasting firm. "Actually, deficit is really a misnomer. Chasm, gorge, black hole, infinitely deep well all fit the description better." 15-01-05
"We have been saying that Americans spend ALMOST $2 billion more per day than they earn. Now, we can save a word. Every day that goes by makes us $2 billion poorer." Bonner, Daily Reckoning.
''Oil prices may hit $50 on the possible cut-back of the OPEC production and heightened geopolitical risks in the face of the election in Iraq,'' said Kazuhiro Saito, an oil trader at Interest Capital Management Co. in Tokyo.
"Liberty is lost through complacency and a subservient mindset. When we accept or even welcome automobile checkpoints, random searches, mandatory identification cards, and paramilitary police in our streets, we have lost a vital part of our American heritage. America was born of protest, revolution, and mistrust of government. Subservient societies neither maintain nor deserve freedom for long." Congressman Ron Paul
"We will be seeing some rallies in the dollar this year but I think it's a trend decline of falling highs and lows," said David Bloom, HSBC's director of currency strategy.
"It can work to undermine the reserve status of the dollar and that has big implications globally," he said, adding the euro was being considered as a reserve currency of the future."
"The rest of the world owns $10 trillion of us, or $3 trillion net. That is, U.S. claims on foreign assets run to only $7 trillion. If lots of people try to leave the market, we'll have chaos because they won't get through the door." In a nutshell, the trade deficit is forcing foreign central banks to ingest U.S. currency at a rate approaching $2 billion a day. Buffett continues: "If we have the same policies, the dollar will go down. A continuing fall in the dollar "could cause major disruptions in financial markets. There could be unpredictable side effects. It could be precipitated by some exogenous event like a Long-Term Capital Management," Buffett says, referring to the 1998 collapse of a steeply leveraged hedge fund.
How about a soft landing for our deficit-addicted economy? Don't count on it. We're running $100 billion a year in the hole against China, but Buffett doesn't expect that an upward revaluation of the renminbi (stoutly resisted, in any event, by the Chinese government) would greatly reduce this number. How about a rise in short-term interest rates? They used to say on Wall Street, "Six percent interest will draw money from the moon." Buffett is skeptical, though, that the recent tightening by Fed Chairman Alan Greenspan will do much more than "put off the day of reckoning." Buffett reflects wistfully on the writings of David Ricardo, the 19th-century trade theorist: "In those days the trade imbalances got settled in gold--and when they ran out of gold, people stopped doing business with you." Warren Buffett, Berkshire Hathaway, January, 2005
"The old Wall Street saying - "Put ten percent of your money in gold and hope it doesn't work", is particularly applicable today. Often when I mention this saying I am asked what it means. Why would you hope it doesn't work? Aren't you in the precious metals business? Over the long term, a portfolio allocation of at least 10% to physical bullion reduces overall volatility, improves returns and provides a form of portfolio insurance. With our investment portfolios, we would all like to maintain an optimistic outlook, hoping that the economy will continue growing and our investments continue appreciating. However, since financial markets are cyclical, it is only prudent to maintain some portfolio insurance, in the form of bullion, in case markets move against us. Even though we pay for house insurance year after year, we would still rather that our house does not actually burn down.
Unlike traditional insurance or other hedging strategies, bullion is an asset rather than an expense. It has a price floor approximately equal to the cost of mining it. Unlike stocks and financial derivatives, the value of bullion cannot decline to zero. Because of the recent equity rally, many investors feel that the worst is over and there is no longer a need to diversify and hedge.
However, an increasing gold price is like a financial barometer warning of an impending storm." Nick Barisheff, president of Bullion Management Services Inc.
Ultimately nobody knows what the affect of the Triple Deficits - the record Trade Deficit, Current Account Deficit and Budget Deficits, not to mention the record US Debt to GDP ratio of more than 305% will be.
The US economy may continue to struggle along dragging the global economy with it. However, it seems more likely that these fundamental imbalances will have to be corrected creating a serious recession in the US and indeed a global recession. We hope not but nevertheless feel it is increasingly likely.
Thus, we suggest investors and savers be cautious of those who somewhat irresponsibly encourage people to keep "partying like it's 1999" and continue to buy those asset classes that performed so well in the 1990's. We believe that people should increasingly look to decrease their debt levels as it looks likely that the interest rate cycle has bottomed and interest rates are soon to start rising again.
We also believe it is prudent to invest 5 to 10% of your or your family's wealth in precious metals.
For us precious metals are not about making massive returns although that is certainly very possible.
Rather it is about having in your possession a debt free, hard tangible asset which has been money and a store of value for thousands of years and are the ultimate safe haven assets and financial insurance.
At least a small portion's of one's wealth should thus be saved in or invested in gold in order both for the good possibility of capital appreciation and gain but even more importantly in order to preserve one's or one's families capital or wealth.
© 2005 Mark O'Byrne