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Warsh Warning Words

By Jon Nadler       Printer Friendly Version Bookmark and Share
Jun 16 2009 4:41PM

Good Afternoon,

Just one day after making dollar-supportive statements, Russian leadership was heard making comments of a different kind - albeit not naming the US currency by name. As the BRIC summit got underway in Moscow, Mr. Medvedev made noises about the world needing a new reserve currency. Been there, heard that. There are hints that the BRICs may start buying each other's bonds for starters, but that is far from a significant estrangement from the dollar just yet.

And, they may wish to cozy up to it even further, if rates are set to rise in the future. The Fed's Mr. Warsh warned today that while deflationary pressures have abated somewhat, there is still plenty of progress to be made. None of it, without some costs and adjustments. Like those needed in the attidutdes present among hyper-inflationists out there. Reuters reports that:

"Looking forward, the Fed "will not ... compromise price stability" by monetizing large U.S. budget deficits, he said, warning that higher interest rates were a risk."Financial markets may extract penalty pricing if fiscal authorities are unable to demonstrate a credible return to sustainable budgets," the policy-maker said.

The US dollar's ubiquitous morticians are waiting with bated breath for the day when suddenly everyone bails from the greenback, en masse. Keep on waiting, keep on rooting. Meanwhile, from Tokyo, our good friend Myra Saefong of Marketwatch reports that "The Bank of Japan raised its assessment of economic conditions Tuesday for a second time this year, acknowledging that economic conditions have "begun to stop worsening." That one earns the "description of the week" award. Bravo. To be fair, German economic sentiment also improved, with local analysts looking for a recovery to take hold as soon as the end of this year.

No concrete action on the dollar subject matter is expected from the Moscow summit. Nevertheless, traders took the suspense as an opportunity to reverse Monday's gains in the currency and sold it down to about 80.62 on the index, after which the currency recovered to 80.71 in the afternoon. Gold took its cues from the initial dollar sell-off (as well as from an initial  $1.33 spike in crude oil - itself a reversal of yesterday's losses) and vaulted higher, gaining nearly one percent in the early morning hours of Tuesday.

The New York session continued into the afternoon hours with a smaller $6.00 gain for the yellow metal, which was quoted at $934.90 per ounce following the aforementioned slide in the greenback. Gold turned higher from somewhat oversold conditions in previous sessions, and now needs to tread water above $935 in order to minimize chances of slipping under $915 or lower. As has been very much the case for the month of May, much - possibly all- of this depends on what turns the US dollar executes next. Little else in the way of news appears to otherwise be impacting bullion at this juncture.

Silver initially repaired about half of Monday's losses this morning, opening with a 35 cent gain at $14.37, but such gains were pared later in the day, and the white metal was only ahead by 16 cents, at $14.17 per ounce . Ditto for platinum, which first rose by $23 to $1228.00 per ounce, after yesterday's scrape with the $1200 level.

By the afternoon hours, the advance was limited to but $11, and platinum was seen at $1216 per ounce. Palladium gained $5 to start at $246.00 per ounce, and later turned negative, losing $1 at $240 per ounce. Not all is (still) well in the noble metals complex, however. Rhodium (now at $1360.00 an ounce) is a far (real far) cry from the $10,000 level it visited in 2008. There are reasons:

Bloomberg's Nick Larkin reports that " Rhodium consumption will fall short of supply this year and next as demand from automakers drops to the lowest since 2001 this year, said UBS AG analyst John Reade. Automakers will use 576,000 ounces of rhodium this year, 24 percent less than last year, said Reade, UBS’s head metals strategist in London, in a report today. The metal, used in autocatalysts, will have a 92,000-ounce surplus this year.

Rhodium has plunged 85 percent since reaching a record $10,100 an ounce in June 2008. Higher prices encouraged manufacturers to develop techniques for using less of the metal and the economic slowdown has cut vehicle demand, Reade said. Rhodium traded at $1,500 an ounce at 10:32 a.m. in London, according to data from researcher Johnson Matthey Plc.

“The last time the market was in such a surplus, which was in 2003, rhodium averaged only $530 an ounce, so the current price suggest stockpiling or fund buying,? Reade said. “If it is investors buying rhodium, we suggest they may be in for a surprise. We forecast that the rhodium market will be in a large surplus in 2010 despite stronger auto production numbers.?

In the interim, commodity speculators (the culprits behind last year's giant bubbles in same) are becoming wary of the G-8. Why so? Well, they might just need to get ready authentic 'manipulation' should the continue to enjoy getting carried away with their wild bets. A topic that appears not to have made the rounds following the G-8 summit that took place over the weekend, is that of commodities. We all heard about the dollar, its role as a reserve currency, about the exit strategy from the liquidity festival that is now at least two years old, but we have heard...precious little about what might be done about surging commodity prices. Reuters offers this sobering take (and we do note the conspicuous absence of the word "gold" from the report):

Finance ministers of the Group of Eight nations made little mention of currencies or bond yields as they ended their meeting on Saturday, but there was clear evidence of disquiet over oil and commodity prices. French Economy Minister Christine Lagarde said ministers wanted measures to curb volatility in oil and oil products markets, where prices have climbed sharply this year as investors bet signs of an economic rebound will spark demand.

"We asked the IMF (International Monetary Fund) and IOSCO (International Organisation of Securities Commissions) to work with the IEA (International Energy Agency) to propose at least methods of surveillance and maybe of regulation concerning the oil markets," Lagarde told reporters after the meeting.

She added that G8 ministers wanted "proposals...made to producing and consuming countries to avoid extreme volatility like that which we saw a year ago." The finance ministers from G8 countries -- Canada, France, Germany, Italy, Japan, Russia, Britain and the United States -- said volatile commodity prices put at risk growing signs that their economies were heading towards recovery.

"Excess volatility of commodity prices poses risks to growth," the ministers said in their final statement. "We will consider ways to improve the functioning and transparency of global commodity markets." Ministers have appeared less concerned about currency movements in recent months than they were last year, when Western policymakers described exchange rates for the yen and China's yuan as key to righting global imbalances.

At the meeting, both German Finance Minister Peer Steinbrueck and IMF chief Dominique Strauss-Kahn played down the dollar's weakness against major currencies since March. Steinbrueck said he was impressed by the degree to which the German economy was not being affected by the strength of the euro against the dollar.

"I don't see the dollar as being weak, I think the dollar has been today correctly valued by the market," Strauss-Kahn said. "We see a dollar which today is stronger than one year I don't see today a weak dollar and I don't forecast that we would have to expect many changes in the coming time." But Italian Economy Minister Giulio Tremonti said the return of speculation to markets was unwelcome, and made clear that he was especially worried by commodity markets.

"Speculation is coming back, a certain type of finance is raising its head again and doing the same not very nice things it was doing until last summer," he told reporters after the meeting." Concern about this came...from everybody. There is a return of speculation on derivative and commodity markets." Since the end of February, tin prices are up 35 percent while corn, wheat and soybean prices are up about 25 percent. Crude oil prices have jumped nearly 75 percent Finance minister Alexei Kudrin of Russia, a major oil producer, told reporters at the meeting that it was too soon to talk about stabilisation of oil prices. He said Russia would review its oil price forecasts for its 2009 and 2010 budgets in August this year."

And now, back to the obsession du jour: the U.S. dollar. Is it, or is it not at risk of becoming an also-ran? Is it, or is it not what makes the (economic) world go 'round? Is it a terminal case, or is it just a case of the (speculative) swine flu? Hey, they play in commodities, why wouldn't they play in the dollar market as well? They do. Reuters' Mike Dolan dissects the issue and comes up with an unsurprising conclusion. The patient's EKG will continue to look full of sharp ups and downs, but the prognosis is "will live to see many another day." Over to Mike:

"The raging debate about the future of the U.S. dollar's reserve currency status may be masking the real drivers of its near-term direction. Even as Russia, China and Brazil ratcheted up rhetoric about a new global reserve currency and diversifying their huge foreign currency stashes away from dollars, the U.S. currency has staged a remarkably healthy rebound this month.

Against the world's most traded currencies, the dollar has clawed back a quarter of the losses it has suffered since March -- losses that were driven by growing confidence in financial and economic recovery. The billions parked in U.S. money market funds and Treasury securities during the worst of the credit crunch streamed out to seek higher returns in riskier plays such as equity, often outside the United States and significantly in emerging markets.

Fund tracker EPFR estimates that $104 billion has left money market funds since the start of the year and almost $30 billion flowed directly to emerging market equity, mostly since March. But as the stock market rally has stalled, or at least taken a breather, the dollar has bounced more three percent. And this bounce came in the face of persistent Russian and Chinese reserve warnings and ahead of Tuesday's summit between these two emerging giants and their new-found economic allies from the BRIC grouping -- Brazil and India.

So why has talk of diversification by the world's biggest reserve holders not weakened the dollar further? After all, China and Russia hold more than a third of the $6.7 trillion global reserves stockpile and at least 50-60 percent of their combined holdings is denominated in dollars. For sure, it was cited as a contributory factor as the dollar skidded through April and May. And data released on Monday showed public and private holdings of Treasuries held by Russian and Chinese names fell by $6 billion in April alone.

But analysts reckon this is small compared with the massive private sector investment swings in and out of the United States in recent months and probably for several months to come. With equity and bond markets still torn by uncertainty about the next leg of the post-crisis economic story, the dollar's negative correlation with stock market nervousness appears to be re-establishing itself.

As stocks look to lurch lower again, the dollar may well attract another "safety" bid -- just as in the earlier part of the year. Against that, central bank reserve shifts are unlikely to be either sudden or in great size. For a start, major central banks from Moscow to Beijing or Brasilia would have as much as anyone to lose from any sudden or prolonged loss of confidence in the dollar, given they still hold hundreds of billions in dollar securities. Neither would they want to precipitate a financial crisis that could shock the consumers of one of their biggest export destinations.

Also, whenever the dollar weakens, central banks that fix their currencies at least partly to the dollar are forced to buy at least some dollars to maintain that peg. Periods of dollar weakness are therefore met with official dollar purchases -- even if the proportion is gradually less over time. Analysts at Goldman Sachs point out that global reserve accumulation, which peaked about $7 trillion last summer, has resumed as the dollar has weakened since March and as crude oil prices surged. Others point to the more recent debate about emerging countries switching U.S. Treasury holdings for bonds from the International Monetary Fund -- bonds that would be denominated in the IMF's basket currency, the Special Drawing Right.

However, this flow too may prove more marginal in the short run than it first seems. Dollars already make up some 40 percent of the SDR basket, limiting the drop in dollar allocations from about 60 percent dollars at present. As commitments to date from China, Brazil and Russia to the proposed IMF bonds amount to about $70 billion, that would involve a reduction in dollar holdings of $14 billion at most. The IMF itself is adamant there is no risk the dollar's dominant status for some time.

"The dollar is the principal reserve currency in the global economy and will remain so for as far as we can see," IMF First Deputy Managing Director John Lipsky said on Monday. So is this is a story for another day? "The prospects of an aggressive change in the U.S. dollar allocation in the Russian foreign reserves remains very low," Commerzbank analysts told clients on Monday.

"But it is also worth stressing here that the secular move away from the U.S. dollar into other regional bellwether currencies in the emerging markets space is still on, and will probably intensify over the next many years." Goldman Sachs takes a similar view: "We do believe that the dollar will effectively remain unchallenged as the main reserve currency for a long time but there is also little doubt that the constant reserve diversification talk creates uncertainty."

On a closing note, and speaking of Russia, take a gander at the stunning Siberian-produced kilo and other bars, on view at the finest gold bar image bank on the Internet, - your eyes are sure to be impressed. Even is pronouncing bar brands such as "Krastsvestmet" or "Novosibirsk" leaves your tongue in knots.

Until later,


Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal
Direct: 1 (514) 875-4820 ext. 1360
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