July 23 2007

Watch This Space (Part 2)

Back in April, we wrote a piece for Kitco readers accompanied by the first chart you see below. The “space” to be watched was forward value of the US Dollar Index. We stated then that it looked like we were at a watershed level for the Dollar. The first chart below shows the Index as it looked in April, the lower, shorter term chart is current to Friday.  

Back in April, the Index had just fallen through the fall 2006 low, and looked like it was headed lower.  It did drop some more, but gained  strength when US bond yields rallied on renewed sub prime concerns and Fed saber rattling. That respite proved to be short lived, as we thought it might. A number of weaker economic statistics have been released in the US; Bear Sterns had to rescue two of its hedge funds from collapse due to sub prime default and a surprisingly weak Producer Price Index number for June all helped to generate safe haven buying of bonds. Add to that an expected rate increase by the Bank of England and two rate increases by the Bank of China and the selling of the Dollar went from a trickle to a flood.

The US economy is expected to have the weakest growth rate in the G8 in 2007 and there are reasons to think it will repeat that performance in 2008. China, on the other hand, just released another red hot growth number, reporting 11.9% growth for the second quarter.  This is great news for commodity buffs, though the number is so strong that it reinforces the need for tightening measures in China. As impressive as the two rate increases by the Bank of China may sound, they don’t even keep pace with inflation increases. China has widened the band that the Yuan can move in but given how little this currency has increased relative to others it’s clearly still keeping the brakes on revaluation behind the scenes.

An increase in the interest rates on deposits and accompanying lowering of the tax on interest income levels the playing field for Chinese savers a little but they are still getting less than the latest inflation rate of 4.4%. Given the enormous momentum the Chinese economy now has the tepid interest rate and currency response won’t have enough impact.  More rate increases in China are likely.

The US Fed is still muttering about inflation but the weak PPI number and expectation of more pain to come in the housing market make any talk of rate increases ring hollow.  One important thing to note about the Dollar’s current level is that it was reached WITHOUT significant increases in either the Chinese Yuan or the Yen.  We have never been fans of conspiracy theories but we think its likely Tokyo is under continued pressure by the US to keep rates low and the Yen carry trade going.  The enormous liquidity this generates has gone a long way towards keeping US market indices stable and bond yields low.  The fact that it simultaneously weakens the yen which is near a 5 year low against the Dollar is a bonus that is not lost on export-focused and deflation-phobic Tokyo.  Though it’s hard to make any sort of case for a weak Yen and its strengthening would be an added driver for higher metals prices we’re not holding our breath waiting for it to happen.

So where now for the Dollar? The latest value for the Dollar Index is below the 2005 low which was a 20 year low itself.  No doubt you could chart the greenback but it seems an almost pointless exercise given how old any previous lows now are. This is indeed uncharted territory.  Although Euro zone growth is not spectacular, it’s strong enough that we think the European Central Bank will not lower rates any time soon and may raise them one more time this year. The Euro is not likely to get a break from that quarter and the same is true for the resource currencies of Canada and Australia.  Other then short covering rallies and New York based Dollar bulls we see little respite for the US Currency.

There is nothing magical about the current value of the greenback, but it’s wise to remember that many currency traders are chart traders first and foremost. There is real potential for an even more serious dive if sellers see no support level below and momentum on their side.  In that scenario, we’re sure you know which way precious metal prices would be headed.

Eric Coffin
HRA Advisories.

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David Coffin and Eric Coffin are the editors of the HRA Journal, HRA Dispatch and HRA Special Delivery publications focused on metals exploration, development and production stocks. They were among the first to draw attention to the current commodities super cycle and have generated one of the best track records in the business thanks to decades of experience and contacts throughout the industry that help them get the story to their readers first. Please visit their website at www.hardrockanalyst.com for more information.

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