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They Bought...What ???

By Jon Nadler       Printer Friendly Version
Dec 19 2008 4:33PM

Good Afternoon,

Gold prices took their worst fall in three weeks on Friday, as a robust surge in the US dollar diverted most would-be buyers, while emboldening hesitant profit-takers. Poor physical demand in key jewelry markets is obviously still playing a pivotal role in gold's short-term fortunes. We reported on Dubai's 80% sales slump in gold yesterday. Today we tale note of the fact that gold buyers in India are patiently sitting on the sidelines, awaiting an opportunity to buy the metal at near $790 or lower once again. So much for high premia as being a reliable indicator of coming price increases. India does love gold. At a price. Just not this particular one.

Today was also the day when it was the euro's turn to take an uppercut from the dollar and stagger in the ring. Forecasts of a coming 10% decline against the dollar over the next 90 days were issued by UBS. The BoJ reduced call rates to 0.10% but traders felt it will have little impact, and they remain divided on the effectiveness and likelihood of direct intervention to curb the yen's rise. A near half-trillion dollar stimulus package is nearing a launch in economically beleaguered Japan.  The greenback's 1.40 point boost on the index brought it to just above the 81 level and set the stage for a second day of sharp declines in gold and silver.

New York spot gold values remained under selling pressure all day, as traders lopped more points off overbought relative strength numbers seen earlier in the week. Lows overnight were recorded at $829.20 per ounce. Dazzled by gold's 20% December surge, perma-bull analysts once again pulled out the obituary columns looking for a brief notice on a Mr. U.S. Greenback, however the onus remains on the bulls to prove that the December move has not been a false breakout. Silver climbed back to near-term support at $10.82 but still fell by 14 cents to trade at $10.82 per ounce.

Platinum dropped $3 to $850 and palladium traded unchanged at $176. US automakers received an early Christmas present - albeit one that has to be returned eventually, in the form of  an initial $13.4 billion loan. That TARP money, and another $4 billion in loans to be extended in about 60 days is to keep them on life support until March, but the outlook remains as dark as ever. The White House still allows for the 'orderly' bankruptcy scenario as a palatable option.

These interim loans are seen as an attempt to avoid the 'disorderly' unravel of the industry, as well as to keep car buyers buying with the confidence that their new car warranties will be worth something. The news prompted the Dow to rally and silver as well as pgm group metals trimmed losses as well. Later in the afternoon however, stocks turned down on the realization that a GM bankruptcy remains a distinct possibility despite the injection of Treasury cash. Oil continued to struggle and lost $2.35 to trade at $36 per barrel, thus adding to bullion's pre-weekend troubles.

Oil producers have started to wag cartel-ish like fingers at the world, warning that low prices imply future scarcity. Once again, the bugle calls for backing up the proverbial truck at the gold store have been activated. So, it's either the 'train is leaving the station NOW' or 'back up the truck, honey!' - While we strongly recommend that core insurance 10% position in the metal (and always have) and while we would like everyone who owns gold to come out ahead, there is something to be said for not placing all of one's proverbial eggs into something else that is also proverbial.

Apparently, foreign investors are diversifying into precisely the very vehicle that is being derided in every single hard money publication. And then some. The instrument? Treasury bills. Uncle Sam's ultimate promissory note. Whether or not there buyers suffer from severe cognitive impairment or questionable judgment remains to be seen. However, at the moment, the numbers do not lie. October's purchases of Treasuries amounted to four-and-a-half times the amount of bullion the famed GLD has amassed over four years. The New York Times explains:

"AS foreign investors pour cash into United States securities, particularly short-term Treasury bills, they are pulling it out of the higher-yielding bonds issued by the government supported-entities Fannie Mae and Freddie Mac. The moves appear to indicate that even after the government bailout of the two agencies, there is some lingering doubt that the government would actually stand behind their debts if their situation grew much worse.

The Treasury Department reported this week that in October, overseas investors and governments were net sellers of $50 billion of agency securities, even though they yield significantly more than comparable Treasuries, which the investors bought at a record rate. Over the summer, prices of agency securities fell as the financial crisis grew worse and some investors began to doubt whether the “implicit? government guarantee behind the agencies could be trusted. In July and August, foreigners were net sellers of $64 billion of such securities, an outflow unlike any previously seen.

That flight was one reason the government stepped in on Sept. 7 to effectively nationalize the agencies, although shares remain publicly traded. At first investors seemed reassured, but the confidence has now waned. Despite the nationalization, the government has stopped short of putting its full faith and credit behind the bonds. The new data is the first indication that may have mattered to many overseas investors.

The accompanying chart at the top shows the monthly flows this year of foreign cash into Treasury securities and agency securities. More foreign money came into Treasuries in October — almost $91 billion — than in any previous month.

Foreign purchases of government securities

Most of the money — $56 billion in October — has gone into Treasury bills rather than into longer-dated bonds and notes. That flow helped to push down interest rates on bills to historically low levels, sometimes even a bit below zero, as investors sought complete safety. Until the housing market began to show significant weakness in 2007, foreign flows into agency securities were running at almost $300 billion a year, and the flow stayed strong until the summer scare.

The other chart shows that over the 12 months through October, foreigners put just $65 billion into Fannie Mae and Freddie Mac, the lowest for any such period since 1998. Unless there was a revival of overseas interest in those securities in November and December, 2008 could become the first year to see net sales, at least since the data became available in the early 1990s.

Until the late 1990s there was relatively little overseas investment in agency securities. But as the Clinton-era budget surpluses reduced the supply of available Treasuries, foreign investors discovered these investments, which seemed to be close substitutes. Even after large budget deficits resumed early this decade, the overseas demand for agencies continued to grow until questions about their solvency began to be heard.

Now, virtually all the foreign money is going into Treasuries — at a rate of more than half a trillion dollars a year.

An abbreviated trading week awaits, and along with it a thinly traded market with fewer participants at the controls. Maybe not the best time to go on a gambling spree.

Pleasant weekend to all.

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal



Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.