Gold Forecaster - Global Watch
Too much money looking for a home.
Cast you mind back to previous currency declines in currencies other than the $, so bad that the national authorities of those nations believed they needed intervention to hold up or down exchange rates [Deutschmark - Pound - Lira etc]. These happened in the early seventies, eighties, nineties and the noughties we're in now, so this is by no means new to the currency world. For instance, the Bundesbank repeatedly had to back off holding the Deutschmark down, as speculators matched their intervention, in the seventies. Later the Bank of England paid a very heavy price before it just had to give in to the attack on Sterling [thanks to George Soros]. Then, in the Eurozone area, remember the Lira pegs of Europe's Exchange Rate Mechanism? Well it ain't over yet! Lately we're seeing it on the Persian Gulf O.P.E.C. states and now in Hong Kong].
But when the going really gets rough it won't just be the hedge funds reaping a large crop of profits, but we'll see nations pulling out of currencies and piling into others. At the extreme, small nations thinking they suddenly had become the darlings of international investment will have to build walls to stop the inward and outward flows of funds far larger than their competence to contain them. Surplus holders finding it difficult to find a home for their investments will watch as their values decline. At the same time watch speculators, aggressive predators of the markets, charging into the herds of major investors trying to organize changes in their portfolios in an orderly manner, bring bouts of panic into the currencies separated from the herd.
Unlike the wild, speculators will not be sated with one victory, but invigorated and will go onto the next until the tsunamis of capital waves have run their course and the weak currency authorities accept their losses in the form of much lower exchange rates and an obligation to bring value back to their money. Or will nations let themselves be infected by inflation and see currencies cheapen as they try to retain export competitiveness in concert, giving the impression of continued order? No doubt they will do whatever works for them in the short-term.
Will the solid Eurozone be able to withstand the pressures of a strengthening € or will members such as France and Italy threaten to break ranks, while Germany smiles under the umbrella of the E.C.B.? Can the € contain the member nations howling as their economies demand different remedies, different interest rate levels and different protections for their own economic health to the dominant Eurozone?
Has the global economy been infected by the ills of the States beyond its own strength?
If only China would let all this money into there and let the Yuan rise the problem would be solved, then all could enjoy the profits from a rising Yuan, but that is precisely what China will prevent, because it then becomes the victim, stunting its own growth in the process. Jim Rogers is trying to get in there and quite rightly from an investment point of view. But why should the Yuan accommodate someone else's currency mismanagement? Brace yourselves and hide in gold.
Banks, hoping to rebuild confidence?
The securities that caused the "Sub-Prime crisis" are still not saleable. The only way they can be made so is if assets are put into the packages to completely offset the problem assets and give the securities real value. Until then, no moneyman in his right mind will touch them. At best they will go at basement prices or be put into the hands of hedge funds like Bridge Asset to be re-packaged as distressed debt and gratefully given some value.
Right now some major banks are in the process of trying to put together a package aimed at convincing the banks responsible for this mess and others involved that these securities [including Special Investment Vehicles] will have real market value. We don't know yet whether the sponsoring banks believe this is possible or not, but under the worried eyes of the U.S. Treasury, faltering efforts are being made to make it possible. The new entity, called a Master Liquidity Enhancement Conduit, or M-LEC, could raise as much as $200 billion or more through the issuance of its own securities, and use the money to buy securities that otherwise might be dumped on the market. We find it surprising that bankers should even attempt to convince other bankers of something they don't believe themselves and actually put their own money up to do so, but there it is and we await in awe for the presentation of this crisis' solution.
Or is no solution on offer? Are we going to be told that the banks will be there to lend money to those in distress, while hoping they won't have to? After all the numbers being put up are so small, relative to the amounts involved, they can only be there to give an impression of helping? Simply put, the scheme is a front that they hope will prevent a fire sale.
Of course if they fail, they could precipitate a far worse crisis than the one we saw in July and one that will take a very long time to recover from. Imagine the sight of disrupted credit market and a Fed desperately trying to pick up the pieces while not actually saving the investors themselves. What does the Federal Reserve believe about the crisis? The Federal Reserve Chairman said recently, "Despite a few encouraging signs, conditions in mortgage markets remain difficult.... A weak economy, he added, could reinforce problems in the credit markets".
Not too encouraging, I'm afraid.
The reality is that global credit markets are in trouble, confirmed now by the first IKB Deutsche Industriebank AG Structured Investment vehicle, which has lost about half its value and is unlikely to repay all its debt. Rhinebridge suffered a "mandatory acceleration event" after IKB's asset management arm determined the S.I.V. may be unable to pay back debt coming due, the Dublin-based fund said. Rhinebridge had $1.2 billion in commercial paper outstanding as of Oct. 5. Rhinebridge, Cheyne Finance Plc and other S.I.V.'s, which borrow from the short-term commercial paper market to fund purchases of asset-backed securities, have struggled as investors retreated from all but the safest debt. S.I.V.'s have dumped about $75 billion of assets as a result, prompting U.S. Treasury Secretary Henry Paulson to organize an $80 billion bank-run fund to buy some of the securities. In August, Rhinebridge had to sell $176 million of its assets to cover obligations, and as much $320 billion of holdings by S.I.V.'s worldwide may be dumped if the market doesn't improve.
The path forward for credit markets is not a happy one! Gold is no-one's obligation, so this is again gold positive.
Capital Inflow Controls have started.
India alone in one fortnight during the second half of September received inflows of over $15bn, compared to barely averaging $16bn annually during 2000-2006. Emerging equity markets are up over 440% since 2002 compared to barely doubling in the US and a bit more than doubling elsewhere in the OECD.
But emerging equities are not yet overpriced. Emerging nations are good growth stories, particularly for those oriented towards China. Many emerging nations are creditors now as growth infuses vast flows of capital to them. No doubt as the developed world shows a poor performance relative to these rapidly growing nations, alongside commodities, superior returns are being achieved.
The excessive amounts of capital, a consequence of deficit trade financing, [far too much money] will attempt to squeeze into those markets, taking values beyond achievable expectations, leaving a empty big drop below prices should the expectations turn bad. But where the growth does continue in the nations providing commodities for the major growth nations such as China, prices will hold at higher levels, as the price will be in depreciating currencies, such as the U.S. $. Hence, as with oil, these prices will not be seen as high once the depreciated value of the currency is brought to bear. But there is such a huge amount of capital readying itself to move into sound markets, the dangers of overpricing will have to trigger nations to prevent asset bubbles from forming with capital inflow controls.
Right now many, many large institutions are researching the gold market, the commodities markets and are as keen as ever to go into emerging markets. Just a tiny portion of the institutional money lying around, estimated to be just under $200 trillion a massive tsunami of capital, is in part, about to go walkabout. And if they can get in, most emerging nations are just not capable of absorbing these flows. As in South Africa's case where they are getting in the country can become a fool's paradise believing they have attracted such capital because they are attractive investment homes. A dropping interest or exchange rate will soon cure that.
So what can these poor nations do? As we wrote last week, many will turn to impose Capital Inflow restrictions. To those who remain unbelievers and think we are pipe dreaming, please note that recently, the Indian government recently moved to impose restrictions on non-resident equity inflows, which led to a sharp correction in the Indian stock markets and the INR, from which the Indian markets have only partially recovered. The curbs were thought to [reasonably so, in view of the Bank of India's objective] keep the Indian Rupee low against the U.S.$. Since then the Rupee and the Stock markets have recovered to some extent.
As we have written in last week's issue we warned that many emerging economies will find it impossible to continue current policies that attempt simultaneously to target exchange rates and the pursuit of independent monetary policy, while allowing the free movement of capital. This trilemma is just not workable, so be certain that such and similar measures will spring up in many other countries.
In such a climate gold and silver have always proved themselves in times when governments have to intervene to control money directly. This time we will see it on a broad global front. Gold Forecaster will be providing a guide to what can happen under Capital and Exchange Controls and how to cope with them.