Financial Sense "A Walk Down Currency Lane" by Jim Willie CB 03/21/2006

A WALK DOWN CURRENCY LANE
by Jim Willie CB
March 21, 2006

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Jim Willie CB is the editor of the �HAT TRICK LETTER�

For specific detailed analysis of the Gold, USDollar, Treasury bonds, and inter-market dynamics with the US Economy and Fed monetary policy, see instructions for subscription to my newsletter research reports, which include stock recommendations positioned to rise in the commodity bull market.

The following editorial is excerpted from Hat Trick Letter. FSO

GOLD MIGHT HAVE FINISHED ITS �REST�

With little argument from anybody, gold has made a huge run since last autumn. Typically, in a strong bull market, most of the gains will be retained. Often a retracement of 3/8-ths of the gain from the breakout occurs into clear ground. In our case here, the gold upward path was painted by too many geopolitical brushes. Gold benefited from the monetary response to the natural hurricane disasters which persist. Gold was pushed by too many participants fed up with the bloated world currency, the most mismanaged currency in modern history, the USDollar, which fights the good fight in battling the inefficiencies of debt overhang and the threat of asset bubble dissipation.

The gold chart reveals a pause configuration known as a �bull flag� pattern. It gives some back, but not much. It backs off, but is resilient. Consolidation has taken place as it gathers strength under the surface. Steeply growing moving averages must slow their pace. Digestion in the form of changed hands, from weaker to stronger, is in progress. Lastly, a monumental shift is in progress whereby Westerners shed their gold to Easterners. The US and European bankers are handing off their gold (and future power) to Asians, in particular China, India, and Russia. February and March bring the pause that refreshes. We see a classic �bull flag� indicative of continued gold price gains. It is a reliable continuation pattern.

THE EURO HAS BEGUN A STRONG REVERSAL

The euro currency refused to break down in the face of rising US interest rates since last summer. My forecast last autumn was for the 119 level to hold. It did not, pushed down from the political chaos associated with the �NO� vote for a constitutional union and centralized power in Brussels. A reversal did occur toute de suite, so to speak, as currency traders realized the union vote bore little significance on the newly hatched continental currency. Rumor of a new tightening cycle was followed by actual Euro Central Bank tightening, but with a denial of any new trend with more than one hike. That was not believed here at the Hat Trick Letter. Trichet made some bogus comment, meant to aid the USDollar, probably coerced. More FedSpeak exported. The motive is transparent and obvious, since the USFed is near the end of its tightening cycle. Higher interest rates support the USDollar. My Zurich sources tell me that big New York City money center banks are securing big positions in favor of the euro right now, and have been for a few weeks. Euro price action reflects this vividly.

Now in hindsight, the Nov2005 euro swoon can be deemed �slippage� which is technical analyst talk for a fixed booboo. The gap of May2005 was filled in Sept2005. The messy reversal Cup & Handle from Nov-Dec 2005 saw its potential target of 122.6 almost realized (close enough). The second ECB rate hike in Feb2005 (which made them look silly for past denials) has given lift to the euro�s sails. More rate hikes can be expected, prompted by higher CPI in Germany and Europe, which they do not falsify so much like the USGovt does. Check out the newly emerging uptrend channel. My forecast of critical support at 119 is looking more correct than erroneous. The next target is 122.5, then 125, then 129.

The contango is healthy in the futures contract, marked by rising prices for the more distant monthly contracts. The euro remains the principal competitor to the USDollar as a reserve currency. Little reversal patterns are littered within its chart. The lesser known, little respected euro carry trade is also unwinding. See the Iceland market damage three weeks ago, as their govt bonds were downgraded by Fitch. Much pain was doled out to both their bond values and their krona currency. Such is the fallout from euro carry trade being unwound, motivated by rising ECB rates, signaled by a rising euro currency. Speculators sell their object investment, and pay back their borrowed euro money. Typical objects are gold, the USTBond, crude oil, high yielding emerging market debt, and other commodities (like sugar).

THE JAPANESE YEN RISES LIKE THE SUN

The Japanese economy is enjoying finally an inflationary push. A few months in a row have seen positive consumer price trends. Their car industry is the primary beneficiary from globally higher gasoline prices, taking market share from the US crippled car makers. Why buy a car from a corporation destined for bankruptcy, when Japanese quality is unsurpassed? The unwinding of the yen carry trade will be huge, although probably much slower in its time span than expected. The Bank of Japan does nothing quickly, yet their actions can be decisive. The impact of the yen carry trade unwind, the impetus behind it, the time frame, its size, political pressures, even US influence (or collusion) is all covered thoroughly in the March Hat Trick Letter. Look for more collusion with the debt rating agencies. The effect will be both positive for gold and sure to introduce more volatility. Look for Japan to act in coordinated fashion with China. If one orders a higher currency, or enables it, or endures it, the other will permit their currency to rise in like fashion. Asia will act as an exporting unit, not to disturb its relative pricing

Japan has been reckoned emergent from its deflationary morass so often that when it comes, it might seem a surprise. Yet the BOJ has attempted to make it clear they will hike rates from the near zero level, putting an end to their absurd Zero Interest Rate Policy. By the way, a ZIRP is the biggest black eye any central banker could ever suffer, the greatest ignominy and shame. Correspondingly, selling cars at zero percent with hefty price discounts is the biggest black eye a car maker could ever suffer. Japan emerged from the financial bankruptcy (asset markets). Detroit will also, but since in the real economy, the effect from its painful impact will be real, like lost jobs, lost pensions, and lost control. Look for Toyota to purchase car making plants at severe discounts.

LONG RATES SEE A CLASSIC BREAKOUT & LET-UP

Three very significant factors conspire to foster higher long-term interest rates in the US credit markets and economy. First is the growing distrust and disdain for USTreasury Bonds held by Asians. They are recycling much less of their trade surplus, despite what Buffet claimed today. He said �We buy Asian goods, and we sell them capital assets. They are happy to invest in our financial markets.� No way, Warren. Where have you been? Japan actually owned less in USTBonds in Jan2006 than last Sept2006, down a cool $20 billion. China has increased its USTBond holdings only minimally, up $10.4 billion over those four months. The real support for USTreasurys comes from England. A complex mix of hedge funds, illicit USFed agencies, and OPEC brokered purchases adds up to a big jump in their reported holdings, up from $183 billion to over $244 billion in four quick months. Neither CNBC nor the Wall Street Journal seems urged to explain. Asians and Persian Gulf oil producers have demanded higher yields for their holdings. They will be given exactly that, which means higher interest rates for the real economy.

Second, a combination of rising price inflation (whether admitted and reported officially or not) and a vigorous USFed tightening campaign push long-term interest rates higher. The CPI should be at least 3% greater, if honestly measured. The housing bubble puts the entire USEconomy at risk, from not only its higher prices but its likelihood of reversal. As the USFed hikes rates on the short-term side, the banking community requires the long-term side to follow suit in order to maintain profitable lending businesses. It is my expectoration that the USFed will be fighting an inverted Treasury yield curve until they quit and bring an end to the tightening process. Curiously, they might fight the inverted yield curve even after they stop hiking rates, especially if the USEconomy enters a recession. Long-term rates will fall if that happens, and might go below the official Fed Funds target short-term rate.

Third, the unwind of the carry trades ensures higher US interest rates. Not only the colossal yen carry trade but the smaller euro carry trade have begun to unwind. The easiest trade to envision is the borrowed yen at zero percent, invested in 4% USTreasurys for a profit without sweat. All hail the US financial engineering! In 2004, the rising yen was halted. A steadfast Bank of Japan intervention combined with a China outsourcing movement to halt the yen rise. This aided the yen carry trade, and extended its life. However, with rising BOJ rates comes gradual selling of the USTBonds bought on �carried yen� debt. Expect fits and starts with long-term rates, sure to provide unsettling volatility. For this reason, the USFed will exert considerable pressure on Tokyo to hike in small amounts and to hike infrequently.

In a worldwide tightening mode underway, gold might benefit as an alternative, especially since bond principal value is harmed. A declining US$ exchange rate further inflicts damage. Rather than stand pat and witness declines to mammoth foreign reserves, Asian central banks are likely to migrate some USTBond holdings into gold. Last week, gold purchase was motivated by war concerns from Australia to Hong Kong to Tokyo. In time these two motives will merge and be seen as one and the same.

THE GEOPOLITICAL LANDSCAPE

[...] The gold price has been under correction for over a month. The USDollar appears to be rolling over, set for a fresh decline. The euro currency is jumping after a threatened breakdown. The yen currency is awakening after a long sleep. Long-term yields in the United States have broken out higher, likely to go much higher. A powerful vicious hurricane slammed Australia with 180 mile per hour winds. They are in summer, and offer vivid preview to the US Gulf Coast this late summer. The Dubai Ports World snafu has faded as a story, without any report of the vested personal interest to profit from the deal by highly placed USGovt officials and related family members. At least in the 1960 decade, the press reported how Lyndon Johnson blocked FCC licenses for rival radio and television stations in Texas. Have news networks merged with state interests in recent years? More avian flu diagnoses, with concern over mutations to human communicable strains. Last week was a very interesting week, anything but boring.

[...] In the ancient Roman Empire, their Senate became marginalized as it morphed from a republic to something much worse, finally chaos. In such a dangerous and unstable climate, it is difficult to imagine gold selling off. Any breakout of war on a new Iranian front will undoubtedly cause the crude oil price to spike upward. Whether the Straits of Hormuz are shut down in obstruction, that is yet another question. Any relaxation of tensions with Iran will surely remove $20 to $30 from the gold price, and remove $3 to $5 from the crude oil price. An ignited new war front will send the crude oil price to heights unseen before, and will send the gold price upward in a monthly $100 jump easily.

CONCLUSION

[...] My view is that a return to normalcy is poppycock, never to happen! We have gone so far afield, so far from anything recognizable or rectifiable, that normalcy is not even remotely possible in the gold and crude oil markets. The USFed will tighten until they cause a crisis, then deny their role, then clean it up, probably followed by easing of interest rates. The next LTCM fiasco lies around the corner, under the surface, ready to be revealed, sure to wreck havoc. Gold and crude oil will be given a grand assist when it happens, not if. It is guaranteed since the USFed can no longer even define what �neutrality� means in its policy. Besides, what it says usually obscures its actual policy motive. My firm belief is that the Enron model was hatched from the USGovt incubator, where it continues.

Geopolitical tensions are elevated. Even when stable, they constantly remain very high. Gold usually thrives in such an environment. The pendulum of time and financial justice swings. We are on the doorstep to the next grand step down for the USDollar and the next grand step up for gold. Expect all hell to break loose when it becomes increasingly clear that the USFed is a blink away from the end of its tightening cycle. That is all that supports the USDollar, held by the tenterhooks of rising interest rates.

Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a Ph.D. in Statistics. His career has stretched over 24 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com.

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