Watching the US markets, including the dollar, rally of late in light of the stream of horrific economic news, including this past weekend's announcement of a historic US government bailout of Fannie Mae and Freddie Mac, was sort of like watching Barry Bonds chase down Hank Aaron's all-time baseball home run record last year.
One watched him being cheered at his home base of AT&T Park in San Francisco as he got closer to that record, but Bonds was booed most everywhere else he played in light of the steroids revelations and his alleged use of them. Human nature and emotions being what they are, the reaction of his "home crowd" was understandable; but surely, they too, in time, would come to realize what everyone else did, despite any short-term hysteria.
That is where I believe we are today with this ongoing dollar rally and continued decline in the gold and commodities sector. Despite the news of physical shortages and delivery delays for the precious metals, their paper prices continue to plunge. Short term "noise" can distort and throw for a loop the best laid out strategies and investments, to be sure.
The external financial shocks of the late 1990's brought on a financial crisis that rocked the world financial system. The Mexican, Asian, Russian, Argentinean and Brazilian financial contagions, as they came to be known, saw investors fleeing to the "safety" of the US dollar and other US denominated assets.
Countries with currency pegs to the US dollar, but also with burgeoning debt, had to follow the US lead and start raising interest rates in the mid-1990's. This led to overvalued currencies through policies deemed by many investors at the time, including George Soros, to be unsustainable. The trap door let go in Thailand, when the Thai government decided to float the Baht, cutting its peg to the USD. Thailand's foreign debt burden had made the effectively bankrupt - the peg had to go.
Fearing a spreading contagion with similar roots, investors soon followed suit with other currencies as well, opting for the safety of the US.
Today we have the reverse of the 1990's. It is the US that is the "home base" of the current financial contagion and has a teetering currency. An increase of short-term US interest rates to support the dollar is off the table -- US debt levels and banks' financial condition simply doesn't allow that as an option -- yet the dollar has seen fit to rise anyway, as we continue to see a flight to "safety" and "quality" by investors.
Investors are choosing to buy the dollar and dollar denominated investments despite the fact negative real interest rates prevail in the US. That is akin to fleeing one burning building -- the Euro and other foreign currencies that will suffer the consequences we are told -- into the "safety" of the inferno next door, completely ignoring the shining beacon of light and safety that is gold.
We have been told for the longest time that gold is a horrible investment since it pays no interest. I don't know about you, but I will take no interest over negative interest rates any day of the week and twice on Sunday.
We therefore continue to believe that gold and silver, as well as oil and natural gas, offer the best protection against the current economic climate. When the markets finally come to their senses, those brave enough to have stuck it through should be richly rewarded.
The MurkyMarkets.com website by Christopher G Galakoutis is a running macroeconomic commentary on the state of the financial markets with emphasis on gold, silver, the currency markets and energy. Visitors to our new site are always welcome.
