Investment Reasons for Buying Gold, Part 1

Source: Julian D.W. Phillips, Gold Forecaster - Global Watch  (10/29/07)

Most of us are still of a mindset to believe that the Fed has full control of U.S. interest rates. If the move out of the $ is not just a reaction to the U.S. banking crisis but a long-term trend, then the sales of Treasuries will of itself lead to higher interest rates, leaving the $ surplus holders of Asia in control of U.S. interest rates. The Fed will be left to react but not control.


Moving away from the $

1. Vietnam is planning to cut its purchases of US Treasuries and other dollar bonds, raising fears that Asian central banks with control over two-thirds of the world's foreign reserves may soon join the flight from U.S. assets. The State Bank of Vietnam was abandoning the attempt to hold down the Vietnamese currency through heavy purchases of dollars. The policy is causing the economy to overheat, driving up inflation to 8.8%. Vietnam, which has mid-sized reserves of $40 billion, is seen as weathervane for the bigger Asian powers. Together they hold $3,575 billion of foreign reserves, over 65% of the world's total. China leads with $1,340 billion, but South Korea, Taiwan, Singapore, and even Thailand all built up massive holdings. Vietnam's central bank said this week that it would move "gradually" to a floating currency. Vietnam is a relatively small country but it is symptomatic of Asia.

Should one of them jump the $ ship, the others will follow sooner or later.

2. Kuwait has already abandoned its $ peg, fearing that its economy would overheat if it continued to import America's loose monetary policies. Separately, the gas-rich Gulf state of Qatar announced that it had cut the dollar holdings of its $50 billion sovereign wealth fund from 99% to 40%, switching into investments in China, Japan, and emerging Asia. The move is intended to increase long-term returns for future generations, but it can easily be seen as a vote of no confidence in US currency management. Qatar will not have a significant impact on the $, but is being watched by the other members of O.P.E.C. All are concerned by the fact that the U.S.$ is cheapening by the day. The dependence on the U.S. may hold, but that frustration will show itself in the rising and holding price of oil. The U.S. will at some point come to terms with O.P.E.C. and give it a better deal than it has now. Will that be that they permit O.P.E.C. to price oil in currencies other than the $?

3. There have been reports that China is already pulling out of U.S. bonds to fund its new sovereign wealth fund. Foreign central banks slashed holdings by $32 billion in the last two weeks of August. We will not know which country was responsible the Treasury's TIC data is released in November. This is gold positive in the long-term.

The I.M.F. promoted the $’ fall I.M.F. Managing Director Rodrigo Rato, said financial market turmoil had increased downside risks to global growth. Rato said currency adjustment seen so far would likely help bring a significant but not substantial reduction in the U.S. current account deficit. He then stated that there was still room for depreciation of the $.

The U.S. government needs policies to increase both official and private savings so as to reduce its reliance on foreign borrowing, but this is not and is unlikely to happen yet. There are as yet no signs of any moves to stem the Trade deficit by the U.S. Authorities, nor are any expected.

What we are seeing already is proof of just what foreign investors in U.S. Treasuries can do if they become unhappy [the sharp fall to negative levels into the U.S. Capital Account]. Were it not for the inflow from U.S. / British owned liquidity funds [under the direction of the Fed?] in the Tax haven Islands of the Caymans the U.S. Balance of Payments would be in disarray now. In that scene we can expect a more disorderly decline in the value of the $ and possibly but less likely higher U.S. interest rates. This could not be more gold positive.

Surplus holders dumping the $. After the seizure of parts of the capital markets over the summer and after the Federal Reserve's 0.5% rate cut, the U.S. yield advantage over other countries diminished and will drop further as more rate cuts are made. This has triggered serious withdrawals of capital from the U.S. and will keep doing so until growth is safe.

In August, Japan and China led a record withdrawal of foreign funds from the United States in August. Data from the U.S. Treasury showed outflows of $163 billion from all forms of U.S. investments. With the market still affected by the August crises we can expect the outflow to continue into September’s figures and October’s.

- Asian investors dumped $52 billion worth of US Treasury bonds alone.

- Japan ($23 billion).

- China ($14.2 billion)

- Taiwan ($5 billion).

Central banks in Singapore, Korea, Taiwan, and Vietnam have all begun to cut purchases of U.S. bonds, or signaled their intention to do so. In effect, they are giving up trying to hold down their currencies because the policy is starting to set off inflation.

It is the first time since 1998 that foreigners have, on balance, sold Treasuries. And what an impressive outflow in one month we’ve seen. It is not just foreigners who are selling U.S. assets, Americans are turning their back as well.

America has relied on "hot money" from abroad to cover 25% to 30% of the U.S. short-term credit and commercial paper market over the last two years. The U.S. requires $60 billion a month in capital inflows to cover its current account deficit alone and this inflow is slowing down, threatening the U.S. Balance of Payments over a much longer term period, something that will produce global earthquakes in exchange rates, major capital flows and see a battery of national [Exchange Control] walls spring up to protect individual nations.

From what we believed are institutions under the control of the U.S., based in the Cayman Islands capital was brought in to the extent of $60 billion from “hedge funds” based in Britain and the Caymans, which covered U. S. capital shortfall and positions at the height of the credit crunch.

Most of us are still of a mindset to believe that the Fed has full control of U.S. interest rates. If the move out of the $ is not just a reaction to the U.S. banking crisis but a long-term trend, then the sales of Treasuries will of itself lead to higher interest rates, leaving the $ surplus holders of Asia in control of U.S. interest rates. The Fed will be left to react but not control.

But is that all that will happen in the financial markets, a declining $ and potentially higher interest rates? No, oh no! This makes gold a must in all portfolios.

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