Gold & Currency Wars

Jim Willie CB
Jim Willie CB is the editor of the "Hat Trick Letter"
Nov 22, 2007

Use the above link to subscribe to the paid research reports, which include coverage of several smallcap companies positioned to rise during the ongoing panicky attempt to sustain an unsustainable system burdened by numerous imbalances aggravated by global village forces. An historically unprecedented mess has been created by compromised central bankers and inept economic advisors, whose interference has irreversibly altered and damaged the world financial system. Analysis features Gold, Crude Oil, USDollar, Treasury bonds, and inter-market dynamics with the US Economy and US Federal Reserve monetary policy.

The competing currency wars are beginning to escalate. Since 2002 the battles have certainly shown signs of economic damage. But they are really heating up. The winners are difficult to define. The losers are all nations involved. The important viewpoint is to identify which nations and economies will lose relatively less, and how they manage the warfare so as to gain an advantage over rival nations. The losers are clear. They are the United States and all nations which hang on with their tight US$ peg for political reasons. It is difficult to identify China (plus Hong Kong) and Arab oil exporters as uniform winners when their economies are suffering some blatant distortions of their own. However, their magnificent growth in savings accounts enables them to show booty from the battles. Too bad the hoard is largely in the form of debt securities laced with acid (US$ brand name) and often fraud (Wall Street specialty). The currency wars are escalating in an open public manner under the full view and debate from analysts and public officials. As the battle rages, central banks will flood the global system with an avalanche of money. They have few other weapons to fight with, and they have grand experience in using such weapons. They will combat asset deflation, such as with housing and mortgage bonds, which each moved from the plus side to the negative side of the asset inflation ledger. This is a massive uphill battle.

OPEC THREATENS PETRO-DOLLAR
The OPEC nations gathered, met, left some microphones 'accidentally' open, discussed oil issues, but also currency matters. As a group, they are nervous about both the decline in their reserve holdings from the USDollar, and the internal maelstrom of price inflation within their local economies. They must maintain similar interest rate policy and money growth practices in order to maintain their highly destructive US$ peg, resulting in big festering problems. Price inflation is rampaging at 14.7% in Qatar, at 9.3% in the United Arab Emirates, and at 4.9% in Saudi Arabia. They have not learned how to lie about statistics, but the USGovt might offer assistance. The open mike revealed Saudi concern over a collapsing USDollar. The group of Gulf Coop Council nations will inevitably dump their US$ tight peg in favor of a basket. Kuwait was just the beginning. Such a basket already exists within the Arab world, but my forecast is that the Chinese yuan basket will be formally adopted as a compromise measure. China carries clout, and their basket will be too convenient for transactions. The effect on the USDollar exchange rates will be a quantum drop down, much akin to the living room floor falling, likely to take the US DX index toward the 70 level. The furniture will be facing basement walls with the television set and lamps upside down. The foreign currencies will power to new higher highs. The movement is broad, heard from radical corners and central areas, from Venezuela and Iran to the United Arab Emirates. The UAE seems to be the ombudsman of the Arab nations, lobbying for a formal abandonment of the US$ and adoption of a more reasonable practical basket of currencies including the euro as a major component. WE ARE WITNESSING THE FRACTURE OF THE PETRO-DOLLAR DEFACTO STANDARD. Earthquakes to the global banking are assured. In response, foreign currency mismanagers (central banks) will attempt to lower interest rates, so as to weaken their currencies, even as high currency exchange rates damage their economies. The competing currency wars lift no victors. This is discussed in more detail in the November Hat Trick Letter.

YEN HITS RESISTANCE
The Japanese yen currency has had quite a double decker runup since the summer. The yen appears to want to consolidate and regroup. Much talk centers on the gradual unrelenting unwind of the Yen Carry Trade. The May 2006 high at 91 is in danger of breach. Never under-estimate the Bank of Japan. They have consistently found reasons to forestall a yen bull market for several years. The yen exchange rate is currently way above both moving averages, extended. The BOJ refused to hike interest rates earlier this month, citing reduced forecasts on economic growth, higher energy costs, and endangered US consumers. Expect some serious BOJ intervention to keep the yen down. At risk are the Japanese export trade and the Nikkei stock market. A paradox has occurred. If the Yen Carry Trade is unwinding, we are witnessing only half of the outcome, namely higher yen levels. Where is the sale of USTreasurys on the upper end of the unwinding YCT? It is occurring, but see the next section on price inflation for a very plausible explanation for the absence of a USTBond selloff, falling bond principal, and rising long-term interest rates. The illicit games have escalated, along with the currency wars. Rigging the system goes hand in hand with war. In war the first victim is truth. In currency wars, initial victims are equilibrium based markets, honest statistics, and fair trade. The consequence of two decades of currency suppression for Japan is that they own a boatload of corrosive US$-based bonds, destined to fall in value. To this victor in the currency wars goes bad paper, corrosive savings in US debt securities. This is discussed in more detail in the November report.

SWISSY BREAKS OUT
One should note that the Swiss franc did indeed vault to multi-year highs last week and this week. Featured last week, it rested not at all. The swissy avoided much of any correction recently, and established sequentially higher highs on five consecutive weeks. Notice the 90 handle, and its reach above the 2004 highs. Power will soon return to Switzerland for global banking. An alternative to the USDollar as an investment currency is being utilized effectively. This is a tectonic shift not reported much in the financial media.

The euro has risen above 148 again. Wow, what a brief correction! The British pound sterling has risen back above 206. Its correction down toward 195 is written in stone. At these levels, both nations restrain their domestic economies much like with a higher official interest rate. In fact, the currency 'tax' slows their export trade, acting like a headwind. England has no export trade, so its housing foundation (insane like US) will wither on the vine and probably cause eventually an insolvent banking system, just like the US, at least for the bigger money center 'casinos' which masquerade as banks. That is already happening. The Euro Central Bank and Bank of England need not hike rates, even though Trichet at the ECB wants to. The damage to come from a higher currency is assured. In the competing currency wars, to this victor in the currency wars goes a slowdown in export trade, dislocations in the economic base foundation, and typically a distortion in the financial markets. German possesses expertise in hedging against currency movement though. The base usually sees some functions, such as manufacturing and increasingly services, shipped abroad. The US saw precisely that during the 1990 and 2000 decades in spades. The consequence is a hollowed out USEconomy, overly dependent upon housing and asset inflation in order to sustain activity. To Europe and England, continued easy money, in time with even lower rates, will power gold upward. Gold is in an uptrend bull market in almost every single global currency, a feature only to be accentuated in coming months!!!

THE NEXT USFED RATE CUT
The USFed delivered its toothless bluff of balanced risks, for economic growth versus price inflation. The very next day, Wall Street banks and the Detroit carmakers put the kibosh on their bluff. Massive bank losses highlight the risk to obstruction to the credit flow for the USEconomy. The entire retail sector is stalling, led by cars. Housing is a two-ton ankle bracelet. By the way, any retail figure under 5% for growth is recession, since that is not an inflation adjusted statistic. The USFed will be obedient to two things. 1) Wall Street bank masters who secretly tell it precisely what to do, when to do it, and how to do it; 2) the 2-year USTreasury Bill, whose yield is now almost 1.5% below the high Fed Funds target. The futures market points to roughly a 100% chance of a 25 basis point USFed rate cut in January, and roughly a 100% chance of another 25 basis point rate cut in February. The immediate effect of such rate cuts will be for gold to power toward 1000. When it happens, much broader attention will come to the gold mining stocks. The housing market must be rescued with lower mortgage rates, which is happening. Lower rates are only half the problem though, as banks distrust each other as much as borrowers, and thus lend less than they did last year. Loan originations are down. This is discussed in more detail in the November report.

Watch fat Freddie & fatter Fannie, the dynamic bond cesspool processors, each caught with their pants down and their excrement on full display. A $3 billion quarterly loss!!! And this corrupt crippled pair is to serve as the foundation for a revived secondary mortgage bond market? And possibly as a foundation for the new inevitably broad based Resolution Trust Corp? Building a house atop a cesspool is a dicey proposition. Building a centrifuge atop a cesspool can only spread acidic spherical substances throughout the system all over again.

The banking system cannot operate comfortably when the official USFed rate, used by banks to borrow from the Fed, is so incongruous (out of whack) with the prevailing rate in the bond market. Also, Wall Street banks are insolvent, an ugly truth slowly being revealed. The phrase "insufficient capital" means insolvent!!! The Fannie Mae & Freddie Mac horror show sounds a loud shrill echo from the banking world beset by mortgage bond losses. Wall Street will dictate easier money, so they can begin to speculate again. Where? On bond yield spreads for one. On foreign currencies for another. On gold for yet a third. And crude oil too. The financial sewage dumping sites have grown, thus permitting this corrupt gang to hide their losses. A great quote came from the financial markets recently when Wall Street banks were going through the charade of admitting their balance sheet losses. "Whatever they estimate losses to be, eventually they will end up being double." Simple, no nonsense wisdom. The unfortunate fact of life in business has come to the fore. CHEAPER MONEY DOES NOT REPAIR INSOLVENCY; IT ONLY ENABLES MORE EASY SPECULATIVE PROFITS. Gold eagerly awaits the return of very cheap money again. It is coming.

CREDIT DERIVATIVES OUT OF CONTROL
One might wonder why the interest rates are not rising all over the place. Give credit where it is due, to JPMorgan credit derivatives. The total notional value of all credit derivatives in 2Q2007 rose by $7.7 trillion. The total for JPMorgan alone in Q2 was $10 trillion, more than the market. These figures make liars out of their officials, who claim their number has risen since they act as intermediaries for both buyers and sellers. If so, then end users would not show a decline. Also, more importantly, evidence is given on a platter that JPMorgan is buying the hell out of bond contracts in order to accomplish two things.

1) keep all interest rates down, an effective money price cap
2) provide the false impression of a global Flight to Quality in USTreasurys

The truth is that foreigners are dumping USTBonds, even as purchases of US corporate bonds are flat, all the while most FOREX reserves under management are diversifying OUT of USDollars. To be fair, much US-based money is shifting from stocks to bonds. An aside, obscure but important. The 2-year swap contracts build in a full 1% spread on the fixed versus floating contract. This speaks to huge distrust of banker assets, the absence of a flood of private sector money floating around the bond market. It also sheds further liar light on the so-called ruse of a Flight to Quality. This is discussed in more detail in the November Hat Trick Letter.

THREAT FROM SOVEREIGN WEALTH FUNDS
The biggest threat to central bank control, independence retained, and sovereignty for that matter, is the movement toward Sovereign Wealth Funds. The SWFs out there are colossal and growing wickedly fast. China does not own the biggest one, but rather the Abu Dhabi funds take the lead post. A controversy has struck up, one in parallel with trade sanctions against China. This new hubbub is over disclosure and control of SWF funds. The Untied States, with full arrogance and none of the inherent humility usually found in debtor nations, insists on attempting to exert controls over SWF fund administrators. Take about a bad joke! What will the US Congress mandate, that foreign funds cannot own USTreasurys anymore? That they cannot participate in Iranian and African energy projects?

Above is an interesting graphic of major world SWF funds. The horizontal dimension shows the level of transparency, with Norway providing the model for quarterly reports much like publicly traded companies to stockholders. The vertical dimension relates to conventional type of investment strategy employed, such as USTreasurys, corporate bonds, even US agency mortgage bonds. A more strategic approach has more ownership of mining properties or stockpiles or energy projects. This is discussed in more detail in the October Hat Trick Letter special report.

GOLD READIES FOR NEXT MOVE
Gold has completed much of the work necessary to consolidate. So much is happening in the gold market, that a quick summary is not practical. Foreign institutions have hedged their asset positions vulnerable to USDollar risk with purchases of gold. OPEC nations might smell the Petro-Dollar abandonment. The banking crisis begun in the US, exported globally, has encouraged more gold purchases. Basic diversification by nations benefiting from outsized trade surpluses is turning more toward gold. Simple supply problems are evident, as higher gold prices have not brought more gold output to market. This is clear-cut price inelasticity. The banking analyst community has finally begun to write openly about gold and the surge in prices coming soon, from both US$ risk and supply shortages to meet rising demand. This is not a jewelry demand phenomenon, centered in India, although their demand of the metal is at record levels.

On the technical chart side, the breakout is indisputable. Even shills on media networks are caught offguard, as minimal poopoo arguments are made. They wonder where the CPI high index would be if gold signals inflation, without bothering to check money supply growth figures. My preference is to cite the normal bull market retracement guidelines from a weekly close standpoint. The bigger picture breakout rose above 695 by 140 points to 835, using the recent critical resistance and ignoring the abnormal spike in 2006. A 3/8-ths retracement would mark 782 as the invisible support level. So far, that mark has held. After a couple more weeks or days of churning around here, the 800 handle will be a fixture as the push occurs toward 900, then 1000, urged by the next official rate cut. The USFed official rate cut will be a gigantic cattle prod for gold to resume its bull market stampede.

Lastly, the ratio of 10-year Treasury Note yield to the 2-year Treasury Bill yield. The spread between the two bond yields has risen to around 90 to 100 basis points even as the long-term rates have fallen sharply. The 10-yr TNote yield is hovering just above 4.0%, while the 2-yr TBill yield has plumbed toward the 3.0% mark. The widening Treasury yield spread is a loud call for price inflation, present and future, one which provides yet another impetus for a rising gold price. The USEconomy faces enormous headwinds from the internal inflation, much of which is passed on to end product, but some of which harms corporate profit margins. These are stagflation traits. To this victim in the currency wars goes massive cost inflation, far worse energy cost increases than anywhere globally. Europe has almost no serious energy cost increases at all.

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