On August 8, while the athletes of 204 nations (we must admit we didn't know there were that many) were marching into the vast Olympic Stadium in Beijing after a spectacular beginning to the opening ceremony, the financial world decided to stage their own show. And what a show it was!
Unquestionably, the star performer role was reserved for that long maligned currency, the US Dollar. On August 8, the trade weighted index measure of the US Dollar - the $US index or USDX - soared 1.29 points or 1.73 percent. This is one of the biggest one day "rallies" - if not the biggest - in the entire USDX bear market stretching all the way back to January 2002. So big was the rally that Gold, which fell $US 13.10 or 1.49 percent on the day, was actually up against several other major currencies, including the Euro.
It is true that the USDX was gaining ground steadily (and $US Gold and other $US priced "commodities" losing ground just as steadily) in the lead up to the spurt on August 8. As the Commodities Research Bureau (CRB) index accelerated downwards, the USDX climbed. Over the three days August 5 - 7, the USDX gained 1.10 points. That set the stage.
Consider the long "agony" of the US Dollar since its highs set more than six and a half years ago. Consider the gargantuan pile of $US denominated "assets" of all descriptions which the rest of the world, and many US investors too, have accumulated over that period. Consider the paper losses which have been sustained as the $US inexorably sank. Yet there has been no concerted selling of US debt paper - whether it be government, Agency, or commercial debt paper - over that period. Indeed the amount taken up has been growing steadily. It is true that the foreign take up of Agency (notably Fannie and Freddie) paper has slowed to a near stop recently and that US corporations have just about given up trying to sell more bonds either inside or outside the US, but the take up of US Treasury paper has not faltered to date.
Central banks all over the world, but notably in Asia and in the Middle East, have been buying US Dollars as fast as they have been arriving to pay for the inexorable appetite for imports which the US consumer has only recently lost. These US Dollars and Treasury (and other) paper, being official reserves, have been the cause in HUGE monetary inflations all over the world, and especially in the so-called developing world. And all the time, this paper has been losing exchange value against the rest of the world's major currencies.
On top of all this is the gargantuan presence of the "hedge funds". As Doug Noland points out in his August 8 edition of The Credit Bubble Bulletin, the hedge funds have seen nearly ALL their positions go sour on them since the end of June. The biggest, their short position in the US Dollar, has now joined the party.
It is tempting to come to the conclusion that the huge spike in the USDX which gathered momentum early this week and then broke its bonds on August 8 is some kind of clandestine international US Dollar intervention. There have certainly been no lack of precedents for such actions over the past two decades. Indeed, in mid July as the CRB index and the oil price were peaking, there was a short-lived series of articles in the US financial press arguing the case for another episode of "co-ordinated" currency intervention.
But we think the US Dollar surge on August 8 has a much simpler explanation. Similar to what happened to US stock markets in the wake of the SEC's decision to outlaw "naked short selling" on Fannie, Freddie and seventeen other US financial stocks, this was a plain and simple short cover rally.
If this is the case, and we think it is, then the USDX may have more rises ahead of it in the immediate future. The short interest in the US Dollar is vast and has been built up over many years. But a short cover rally on the US Dollar is also dangerous in the extreme to not only the US but to the global financial and monetary system.
Shorts are captive buyers, they must buy to take their profits. Once they close out their positions by buying, their ability to cushion falls in the market is no longer there. As Doug Noland puts it: "If today's dislocation develops into a significant unwind of these positions (short the US Dollar), the market then immediately becomes vulnerable to a disorderly 'melt up' followed almost inevibably by a sharp reversal and disorderly decline." Doug is very polite here. We would call it a sucker rally followed by a bloodbath.
The credit crunch which "officially" began in August 2007 was presaged in June 2007 by Bear Stearns deciding to auction off some of the toxic debt paper (mainly CDOs formed of stapled together subprime and Alt-A mortgage paper) it had avidly accumulated. This auction was summarily cut off when the bids plummeted well below the "valuations" of the paper. From that day to this, the Fed and the Treasury have moved financial heaven and earth to PREVENT any of this paper being valued on any semblance of an open market.
As we reported in the current issue of The Privateer (Number 609 - published on August 3) those efforts have now been short circuited. Over the past two weeks, the National Australia Bank has valued its portfolio of US mortgage paper at 10 cents on the Dollar and Merill Lynch has followed up with a 22 cent on the Dollar valuation. These shocking valuations have closed up the conventional credit "taps" even more as the global network of commercial banks all but shuts up their lending windows.
Now, the "hedge" against the freefall of financial paper markets - the commodities price boom - has turned turtle. On top of that, the hedge against the currency backing this financial paper - the US Dollar - has started to unwind in a huge short cover rally. Foreign holders of US Dollar denominated debt instruments have had presented to them a (you should pardon the expression) "golden" opportunity to take advantage of this rally to start selling their $US paper. So have foreign central banks, who may well have participated in the short cover rally itself.
As the REAL financial and economic situation deteriorates with growing rapidity, the desperation on the financial markets grows and the volatility increases. Right now, Wall Street in particular is celebrating what they are trying to sell as the end of the price pressures ("inflation" in their terms) represented by the commodities boom and the possibility of a desperately needed resurgence of consumer spending. In the real world, those same "consumers" are watching the banking system with growing trepidation while they shuffle whatever money they still have around to make sure that it is all covered by the FDIC.
Gold (and Silver) are commodities, that is true. But they are also alternative MONEYS. In the final analysis, if one wants to protect one's future purchasing power against the regulatory destruction now being perpetrated on the global financial system, there is nowhere else to go. That is why they are so detested by all politicians and all commercial and central bankers. They are the one means to get OUTSIDE the system, and those who run the system literally cannot afford for anyone to break ranks in the current mess.
We have no idea how long this US Dollar rally can last and how high it will go. We are certein that once it runs out of steam, the US Dollar will plummet again. When any market, no matter how large or "vital", loses its "captive buyers", a subsequent massive fall is absolutely assured.
And what of Gold's short interest? Well, the "longs" have certainly run for the exits on the paper futures markets but the "shorts" have not filled the hole they left. Open interest on Gold is down by almost 120,000 contracts or nearly 25% since it peaked at 496,778 contracts on July 18.
(Chart appears here in original analysis.)
(Chart appears here in original analysis.)
We have extended the table below into 2008, even though Gold in all four currencies in the table is now well above its 2006 highs. Gold breaking out to new all time highs in $US terms at the end of January led to bull market highs in all four currencies. And as you can see, in March, Gold improved upon those January levels in all four currencies as spot future Gold closed above the $US 1000 level for the first time ever in the middle of March.
Three weeks ago, we had a new entry on the table for the first time since Gold topped the $US 1000 level in March. On July 17, Gold rose to 103233 Yen. That's a new 2008 high for the metal in terms of the Japanese currency.
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