Gold, currencies at a threshold

With gold consistently spiking weekly, it is becoming like a battle of wills or game of chicken to see who blinks first. Will the gold speculators blink first (any speculators right now actually), the US Fed and Treasury, the Chinese, the Japanese, or the Europeans or even the Mid East oil Sheiks.

Japanese will defend the USD

For one thing, the Japanese kind of made it clear that they intend to defend the Yen from rising anymore against the USD. They unilaterally spent billions of dollars several weeks ago defending around USD 77 on the USDX, an area being defended now. The Japanese can’t tolerate a lower USD. That is an example of the efforts trade partners are going to fighting the USD devaluation.

The speculators of all ranks are speculating on gold and other commodities, but that battle is really a great microcosm of the relationship between the USD and say the US stock market. As gold rises, speculators are betting that US Fed QE will re inflate all markets, and the USD would fall in value. So, short term, the gold bet is that US QE will re inflate markets, but for how long no one can say.

The Chinese are playing a game of ‘Chicken’ with the US Fed. Or rather the Fed is playing with the Chinese. It is not clear who is in the driver’s seat, although I would give long odds the Fed leads that battle hands down. Why? Because the Fed made it clear, in spite of strident objections from the Chinese, that the Fed will continue with a new $600 billion QE program, in this case to buy long term US T bonds…

Which the Chinese are saying is clearly wrong, the Fed using its printing press to bail out the monster US Fiscal deficits approaching $2 trillion a year…or $1 trillion but at that level what is the difference?

And then you add the political instability in the EU with the huge German atomic waste train protests that overwhelmed over 50,000 riot police from all over the EU who had to back off and plead with the protesters after an exhausting one day battle to let the train pass (The protesters were using trucks to block the roads as well as spilling gravel on the tracks while the police tried to move it, this for a nuclear protest, but equally fitting are the French pension riots).

And the incessant French riots, protests, strikes… making it clear that France is not likely going to be part of the EU or Euro solution… but this is all related to trade exports and competition. IE its part of the currency and trade battles. The French problems with the Muslim immigration is another major issue but beyond the scope of this article.

Will QE work?

Will US unilateral QE, in the face of Chinese and now German objections work to reignite inflation and world markets?

It’s clear that the commodity markets, and copper for example, are benefitting at least from inflation expectations generated by new US QE coming online this month, to the tune of about $100 billion to start with. Gold obviously benefits as well as silver.

Trade battles?

The larger issue, aside from whether inflation will rear its head in the US (its already at 4% in China) is whether these trade and currency frictions will erupt into a real currency battle over the falling USD, and whether a trade battle begins with the new more conservative US Congress.

No matter what, since much of this market rally in both commodities and stocks starting in March 2009 is correlated with the last round of world QE that began then and amounted to about $5 trillion, since QE accompanied those rallies, will QE again cause further market rallies into 2011?

It is particularly important at this juncture that the USD and Yen stop rallying. Those currencies rally when markets sell down. We have yet to have any serious correction of the market rallies over the last year and a half. So, if the USD and Yen start to rally again, be prepared or careful of another broad world market sell off. The present battle of the USD at 77 – 78 on the USDX dollar currency basket bears close watching.

Alternatively, if the G20 can come to some meaningful compromises this week, perhaps there is a chance that a potential financial and market sell off can be averted. But so far, in the preliminary meetings, where Germany and China stated they won’t accept trade surplus limits, and the US is unilaterally pursuing QE regardless, and the US and Korea could not agree on earlier trade treaties with Korea.

Also, one other and no small item is the deteriorating situation with the Club Med sovereign bonds, whose spreads are widening again. So, other than the G20 conference coming up, many of the same dangers of a bank crisis appearing again are also with us. Stay tuned.

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Copyright 2010
Christopher Laird
Editor in Chief
www.PrudentSquirrel.com

Disclaimer: Chris Laird is not an investment advisor/professional. This article, and the PrudentSquirrel newsletter and alerts, are general market commentary only. They are not intended as specific advice. You should talk to your own investment professionals for specific advice. Information here is deemed reliable but should be verified by you if you think it’s important.