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Gold, Bonds, and Euros
Oct. 13(Bloomberg) – France, Germany, Spain, the Netherlands and Austria
committed 1.3 trillion euros ($1.8 trillion) to guarantee bank loans and
take stakes in lenders, racing to prevent the collapse of the financial
system
With this $1.8 trillion, and the most
recent rumors of a $250 billion bank stake funded by the U.S. Treasury,
G-7 economies will have flooded the global banking system with over $10
trillion worth of currency.
I’ve been a proclaimed dollar bear for
some time, and this changes nothing except how we look at or define the
title. Many consider a dollar bear market one where the value of the
dollar declines relative to the other currencies. That is fine, and I
wrote last week that changes in the value of a currency relative to
another currency is simply the difference in the money supply growths of
the two currencies, but financial markets are changing fast.
Bailouts Soon to Drive Currency Markets
Going forward, we will no longer be
able to define the dollar’s weakness by its exchange rate with the Euro,
Yen, or any other foreign currency. Instead, we have to look at their
purchasing power relative to tangible assets. The exact reason is the
quote from the Bloomberg article. This is a GLOBAL race to inflate, and
the near term fundamental drivers of forex markets are as follows: the
amount of short term debt liabilities that will need to be rolled over
and leverage ratios of the countries banking system.
You see, governing bodies and monetary
authorities have to guarantee their banking system. They have no
choice. Whether they do it Britain style with an all out guarantee on
banking deposits (soon to be a 100% guarantee in the U.S.), or whether
it’s simply nationalization of the banking system, governments will back
up their financial systems. The alternative is simply not an option.
In order to guarantee and/or bailout a
financial system, money must be created and injected into the banking
system. By defining the amount of short term debt liabilities and
banking system leverage ratios, we can define, more or less, how much
money is going to need, relative to other nations, to be created in
order to bail that nation out. This will be the ONE DRIVING FACTOR in
forex markets for the next phase of this financial crisis.
Please don’t get me wrong. In the
whole scheme of things, the dollar demise is still well in tact. The
fundamental issues we facing the value of the U.S. dollar are still
there, and in a way, unique to the U.S. dollar. These issues will be
covered in future editions of B&B.
Bear Market Rallies Are Just That
This brings us right into the next
issue. Throughout the systematic decline of equities markets, cash and
government debt has been king. So much so, in fact, that U.S.
treasuries were recording some of their lowest yields in history.
This is a trade that will DIE. I
believe that the long bonds trade will explode, and getting short the
bonds will be one of the greatest trading opportunities of our life time
(along with long gold). I can tell you exactly how this scenario is
going to play out.
Equities markets have, or are in the
process of forming an interim bottom. This is not a bold claim as every
analyst and their mother have been claiming this for a week or more. I
think I’ve actually heard the word capitulation more times in the last 7
days than I have in the rest of my life combined.
But contrary to what you hear on CNBC,
this is not the end of the bear market, and this will not be the
absolute bottom. Historically, bear markets last 12-14 years, not 12-14
months. What we must understand is that there are sizeable rallies in
bear markets. The bear market that lasted from 1968-1982 had three
rallies of 40% or more. We are about to experience one of those
rallies.
Like in the 1970s, those rallies ended,
and markets made new lows. WHEN, not if, that occurs here in the U.S.,
investors will be forced to make some decisions. Next time cash and
bonds won’t be king.
The Golden Rule
You see, the same problems that will
drive down our stock markets WILL RESULT IN HIGHER INTEREST RATES AND
MASSIVE INFLATION. The ONLY direction for interest rates is higher.
Please note that I’m not talking about official rates set by monetary
authorities. They will be slashed to near zero levels, but the Fed will
not be able to control our multi trillion dollar economy by manipulating
short term interest rates.
With equities crashing, inflation
running rampart, and interest rates going ballistic, investors will shun
government debt, and I don’t care if it’s a 10- year U.S. bond, German
Bund, or U.K. Guilt. Being short these markets at the right time will
result in truly fantastic returns.
Reading between the lines here, the one market that will be left for
investment will be commodities. Listen, for the last three years I’ve
been saying there will be some notable events that will unleash
commodities markets. The events are based on the notion of commodities
like gold holding two main purposes: a dollar hedge and flight to safety
The first of those events recently
occurred. I’m referring to the collapse of the Euro. The Euro has been
a prominent dollar hedge up until now. That will no longer hold as
Trichet and his cohorts at the ECB began flooding their financial
systems with liquidity. This resulted in individuals who hedged their
dollar with Euros needing to find another option…got gold?
The second event, I’m sure you’ve
figured out by now, has to do with gold’s substitutes as a flight to
security. This is obviously the bonds and cash markets. When investors
realize that bonds and cash are no longer a true flight to safety, we
will see some real fireworks in the gold market. As previously
mentioned, this will most likely occur during the next down turn of the
equities markets. Please remember that the size of the bond market
COMPLETELY DWARFS the precious metals market. These markets will have a
hard time absorbing the liquidity and massive volatility will ensue.
What we are about to be faced with is
the Golden Rule, but it’s not the rule you were taught growing up. My
Golden Rule is very simple: he who has the gold rules. This was the
very first thing my mentor ever told me. It has been true since the
time of pharaohs, and will it will stand true long after we depart from
this world.
Nicholas Jones
Analyst,
Oxbury Research
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