Currency Wars: Euro descending, but what of gold?

Tuesday, Nov 29 2011 by
Currency Wars Euro descending but what of gold

Jim Rickards’ new book, ‘Currency Wars’, has been getting plenty of attention recently as its launch has seen it rocket up the best sellers lists, and not just in the financial and economic world. Jim has also had an interesting spat with Nouriel Roubini recently on Twitter, which still seems to be rumbling on. The title of Jim’s book seems to be rather prescient at this time as we look across the Eurozone and watch the markets generally. Jim advises that we are in the middle of the third great currency war, we find his arguments compelling, and the release of his book is perhaps timely.

Market attention is still largely focused on the Euro zone and a currency at considerable risk. Pressure is building on a wider range of constituent parts of the European currency union as notably Germany finds a debt auction a little more than half subscribed. Germany is no island of fiscal solidarity as Kyle Bass points out in an excellent interview with the BBC’s ‘Hard Talk’ (part 1 + part 2) (many will have no doubt seen this after ZeroHedge helped kick it viral[ish]). Bass cites Germany’s 81% debt to GDP ratio and the fact that, as Professor Peter Bernholz finds in his book ‘Monetary Regimes and Inflation’, Germany has defaulted twice in the last 100 years. We would join Bass and others in believing that the German balance sheet is not strong enough to backstop the Eurozone’s problems. We also think it less than likely that Germany will opt to act as such a backstop anyway.

Surely Angela Merkel’s continued refusal to even table a Eurobond initiative is evidence of this. Even if Merkel were willing to pursue a Eurobond, this solution could be mal-adaptive anyway. The European currency union’s structure allowed certain debt imbalances to build up in its prior guise, and such a collective pooling fiscal sovereignty and liability required to issue a Eurobond would once again open an agency issue. Andrew Lillico of Europe Economics refers us to previous research by Gneezy et al, published a few years ago in the Economic Journal, which found going to dinner with friends on the basis that the bill would be split equally (as opposed to paying for what one consumes) lead to an average bill that is 36% higher. We would urge that this finding is problematic for this suggested pooling of Eurozone debt, which would in fact facilitate continued over-spending.

Against this backdrop of a recent failed German debt auction, Italy conducting a successful but painfully expensive debt auction of its own last week (at a price of 6.504%, the highest since August 1997, and double the October 26 auction price of 3.535%), and the Spanish deciding to cancel their planned 3Y auction, pessimism is the mood du jour.

The EFSF which as a policy response looked concerningly like a fart into a thunderstorm, now appears to potentially be such a small financial backstop that it fails to have a raison d'être. As a policy response Peter Tchir of TF Market Advisors finds this wholly unacceptable and comments that:

‘On a side note, several EFSF members should be fired, replaced or demoted, for their performance. Trying to raise money on something so complex without even a pitch-book is just pathetic and would not be condoned at even the worst run investment bank.’

At just over one trillion Euros the initially presented EFSF ran a significant risk of being just too small anyway, and now a number of EU technocrats blame ‘market conditions’ for preventing the desired leverage of around 4:1 being achieved. ‘Market conditions’ ranks up there with ‘evil speculators’ for fall back phrases over-used by the political class. Leveraging the EFSF was the main solution (given that debt pooling is not being entertained by German) put forward to stop fallout from Greece spreading to European banks and its largest economies, particularly Italy. The aforementioned Peter Tchir bemoans this lacklustre policy response in an excellent analysis called ‘EFSF, we hardly knew ye…’.

In his analysis Tchir suggests that the Fed should buy EFSF bonds and opines that the Fed ‘could justify buying EFSF bonds (at low yields) in an effort to promote market stability and hence employment, and if they do it in Euros the combination of "printing" and "buying euros with that newly printed money" should put a lot of pressure on the dollar. In spite of the inflationary risks associated with that, Ben wants the dollar weak so exports can be helped’. Could such a policy option allow the Fed to play another hand in what Jim Rickards calls the ‘third currency way’? Well, let’s wait and see, but as Kyle Bass points out as an aside there is something rather comical and ironic in that fact that Europe currently has a German Pope but an Italian central banker.

In the meantime it seems central banks elsewhere have been buying gold in further efforts to ‘diversify their reserves’. What this diversification really means to us is reweighting their portfolios in favour of sounder money and away from questionable paper, or as the man of the moment, Kyle Bass, describes it ‘as buying a put against the idiocy of the political cycle’. It seems central bankers are managing their nations’ savings with significant concern for idiocy of the political cycle as shown by the IMF’s latest central bank gold buying data for October. The numbers run like this:

  • Russia bought 19.5 metric tonnes bringing their total gold reserves to 871.1 tonnes
  • Belarus increased holdings by 1 tonne
  • Colombia increased reserves by 1.2 tonnes
  • Kazakhstan bought 3.2 tonnes
  • Mexico purchased a further 0.9 tonnes from recent previous buying

Within the data it appears that Germany reduced reserves by 4.7 tonnes and Tajikistan did similarly by 0.4 tonnes. Germany was apparently selling this gold to its treasury for the production of gold coin memorabilia. This appears more of a minor transfer of public holding to private holding. It would appear that central banks are net buyers of gold for the first time in a generation in a reaction to unprecedented systemic risk and monetary instability. IMF figures are obviously only based on publically available data, and we find anecdotal reports of the Chinese central bank continually and quietly accumulating gold as unsurprising and a natural policy response. If we were a creditor nation we would also be diversifying out of Dollars, Euros, and Pounds whilst Western central bankers make merry with their printing presses. Such central banks still have a way to go in this endeavour. If we look at creditor nations such as China and Russia, both holding major reserves of Dollars and other FX, they only hold approximately 5% of their reserves in gold. Central banks are now net buyers to the tune of over 400 tonnes a year according to the World Gold Council (WGC), when only a few years ago they were net sellers of similar amounts. Eric Sprott finds this 800 tonne demand shift in a 4000 market notable; we agree. If this central bank diversification continues at current rates we believe this large contribution to increased gold demand would result in significantly higher price discovery.

Within this dynamic, we feel it is worth taking a closer look at Russia. It would appear that Russia feels it is onto something here, and it increasing its gold purchases aggressively as a result. When complaining about US deficits and financial irresponsibility, President Medvedev has previously compared the US to ‘a parasite’. Russia is worried about a ‘flawed Dollar’ being the world’s reserve currency, and it presenting a significant threat to financial markets. The Russian central bank is thus re-structuring its reserves and buying more gold in an effort to protect the Rouble and weather apparent stresses within our current monetary paradigm. Within this agenda Russia has also made accusations that many other participants in the precious metals markets have been making for some time, that western central banks have been acting egregiously in the gold market to suppress the price to the detriment to the wider less Atlantacist financial world. A number of macro and gold analysts have suggested that creditor nations, such as Russia and China, could use gold to reclaim financial and monetary power from the Western nations. If you believe he who holds the gold makes the rules, then you may be sympathetic to this argument.

What has been interesting about Russia’s gold buying from 2004 onwards has been the level of political affiliation and grandstanding. Over these years Putin and Medvedev have a made considerable song and dance about Russia’s activity in the gold market. Take a look at the posturing in the photos below.

Russian movements in the gold market remind us of the central bank activity that eventually exposed the structural flaws of the Bretton Woods currency system and also the London Gold pool that lasted from 1961 to 1968. The Fed’s ‘gold window’ was meant to ensure that the world’s reserve currency and monetary focal point was apparently backed by gold. Eventually central banks with access to the gold window lost enough confidence in the dollar and American financial discipline to begin a steady drain of the US gold reserves (international central banks could exchange dollars for gold at a fixed rate). These central banks also saw that the ‘official’ gold price was lower than the real or market price, as the London gold pool was found not to be strong enough to resist the market’s desire for higher prices, and were naturally keen to profit from a bit of arbitrage even an EU technocrat could identify. President Nixon had to close the gold window in August 1971, and the world entered a monetary regime that was for the first time purely fiat and a regime that Doug Noland at Prudent Bear calls ‘Bretton Woods II’. Goldcore finds that:

‘Putin's calculated gesture may have been the most important statement on gold by a head of state since French President de Gaulle praised gold as the ultimate from of money and wealth: "There can be no other criterion, no other standard than gold. Yes, gold which never changes, which can be shaped into ingots, bars, coins, which has no nationality and which is eternally and universally accepted as the unalterable fiduciary value par excellence."’

If Russia and other creditor nations to the profligate west understand monetary history as the likes of James Dines suggest they should in the face of continuing currency debasement by the US and other debtor nations, the simmering currency wars of the last few years may heat up and become rather more obviously observable to the man on Main Street. We feel the circumstances continue to make it prudent for investors to act as Jim Sinclair advised many years ago when he recommended: ‘be your own central bank’. Are individuals acting thus and generally rebalancing their portfolios towards gold? Some are but this has not become a generality yet.


Will Bancroft
The Real Asset Company

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18 Comments on this Article show/hide all

macroeconomix 29th Nov '11 1 of 18

Wonderful to get an Austrian perspective on here .. Well done Will!

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Steven Dotsch 29th Nov '11 2 of 18

There are loads of 'potentially' undervalued gold miners out there. Unfortunately, from our perspective as Dividend Income Investors, hardly any of them feature as dividend payers with a long term track record of paying dividends, or, indeed, increasing their dividends annually.

More about miners' prospects in general , see: 

"For the near term I am concerned about the general softening of prices when we continue to see cost escalation and strong currencies in Australia and Canada,"

Steven Dotsch - Dividend Income

Book: Guide to Dividend Investing
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Steven Dotsch 29th Nov '11 3 of 18

Gold miners' newfound attention to dividends doesn't necessarily mean their shares are now appropriate core holdings for income-oriented investors; see:

Book: Guide to Dividend Investing
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Steven Dotsch 30th Nov '11 4 of 18

Gold Producers Poised Like ‘Coiled Spring’ to Rally: Commodities, at:

"Gold mining stocks are trading at their cheapest level in at least nine years even as the industry’s profits are estimated to almost double this year and bullion trades close to its historic high."

Book: Guide to Dividend Investing
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emptyend 30th Nov '11 5 of 18

Coordinated central bank easing of swap rates suggests that we will be risk-on for a while.....won't do much for gold, bonds or other perceived hedges against Armageddon.

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macroeconomix 30th Nov '11 6 of 18

In reply to emptyend, post #5

Your timing is impeccable EE !

BTW bonds are not a good hedge against "Armageddon" ;)

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Fangorn 30th Nov '11 7 of 18

What on earth happened to gold this afternoon. What a spike - just back from gardening so catching up.

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ohisay 30th Nov '11 8 of 18

In reply to Fangorn, post #7

14.05 Turning back to this suprise coordinated move by the world's biggest central banks to cut the cost of borrowing in dollars, Jeremy Cook, chief economist at foreign exchange company World First gives his explanation for the move:

 Cutting swap costs is the equivalent of interest rate cuts. These banks are now basically providing unlimited US dollars to banks with which to fund themselves. The banks will be hoping this is a turning point in the crisis.

We do not know what caused this decision, we may never know, but the smart money is on the fact that yields on one-year German debt went negative this morning (paying Germany to lend it money).

This may have been a signal that the money markets were a short shove away from complete collapse

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emptyend 30th Nov '11 9 of 18

In reply to macroeconomix, post #6

RE timing I merely watch Bloomberg TV -  certainly it has gone a fair way with risk-on trades since that news....though it is rather surpriing to me that gold has gone notably higher. I never said that bonds were a "good hedge" - just that they were being held as a favoured asset in case of armageddon. One of the "less bad" assets perhaps?

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Fangorn 30th Nov '11 10 of 18

Thanks Ohisay. Interesting coordinated move. Doubt it will suffice though but a welcome bounce in markets. Wish it would encourage some M&A activity. :)

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macroeconomix 30th Nov '11 11 of 18

In reply to emptyend, post #9

One of the "less bad" assets perhaps?
Not even close.. if things really got that bad who on earth would want to own government debt let alone expect to trade it with someone for something useful?

Nope, holding onto real assets in times of crisis is what its all about. i.e. "stuff" and the productive property that produces "stuff".

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emptyend 30th Nov '11 12 of 18

In reply to macroeconomix, post #11

One of the "less bad" assets perhaps?
Not even close.. if things really got that bad who on earth would want to own government debt let alone expect to trade it with someone for something useful?

Well I've owned a slug of it over the last 4 years as yields have collapsed from 6% to 2%...and haven't done too badly whilst the FTSE100 has lost 1,200 points..........

Don't be too purist....

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macroeconomix 30th Nov '11 13 of 18

In reply to emptyend, post #12

;) Congrats! Gold hasn't done too bad either.

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Fangorn 30th Nov '11 14 of 18

I suspect yields have fallen about as low as they are going to UST side. Next more in Interest rates must surely be up, at some point as investors demand a higher risk premia as their burgeoning debt issue comes to the fore (once of course the Eurozone has imploded, along with the UK)

The markets however aren't focusing on the US just yet but when they do I expect the fallout to be even more significant than the hapless Eurozone induced ones we have been seeing recently - and it will make the Lehman's debacle look like a walk in the park.

All in my opinion of course,and yes, I am very bearish on any solution being found to the debt issues the western world faces.

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nigelpm 30th Nov '11 15 of 18

In reply to Fangorn, post #10

Thanks Ohisay. Interesting coordinated move. Doubt it will suffice though but a welcome bounce in markets. Wish it would encourage some M&A activity. :)

Had this debate with someone on TMF.

Basically M&A is picking up dramatically of late.

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Fangorn 1st Dec '11 17 of 18

In reply to nigelpm, post #15

Oooh really. Grateful if you could link the thread so | can peruse.

Given many companies have significant cash on their balance sheets am hoping that this leads to M&A in several sectors - Oil, Mining and Finance(Insurers), specifically in those companies where I am invested :)

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Steven Dotsch 2nd Dec '11 18 of 18

Earlier this week, in a swift move, China, the United States and Europe are making moves to add liquidity to the markets. Stockmarkets loved it! These actions, some of which were meant to demonstrate that there won’t be a liquidity crisis like 2008 as the European debt crisis comes to a head, will in fact be very inflationary.

All this should be good for gold, as the creation of liquidity in 2009 and 2010 was bearish for the U.S. dollar. As gold usually moves inversely to the U.S. dollar, the latest liquidity flood should be positive for gold bullion prices going forward.

These actions come at a time when gold and gold stocks are relatively cheap . A recent Bloomberg article (see above) pointed out that most gold stocks, when measured by P/E metrics, are the cheapest that they’ve been since 2002.

The ratio of most gold stocks is about 17 times earnings at the moment — compare that to the 10-year average of 37 times earnings and you quickly see the situation at hand. However, when you DYOR you will find a select number of profitable gold miners at substantially lower p/e's. Unfortunately, though, many do not pay any dividends (yet), such as AIM-listed Goldplat, but some could feature in more speculative value/growth portfolios.

Steven Dotsch - Dividend Income

Book: Guide to Dividend Investing
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About Will Bancroft

Will Bancroft

Will is Co-Founder and COO of The Real Asset Company, a platform for buying gold and silver bullion efficiently online, stored in a global range of vaults. Will manages digital and operations, also finding time to contribute to the Research Desk alongside Jan Skoyles. He is Austrian in his economics, liberty minded above all else, and an active DIY investor. more »


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