That is the headline in the business section of my local newspaper, the Brisbane Courier Mail, for Saturday, January 31. I have seen similar headlines in newspapers all over the world in recent days. No doubt you have too.
The gist of the article which accompanies this particular headline is that the $US 16.10 Gold sell-off which took place on January 29 was in reaction to "fears" of a stronger US Dollar. Why has this sudden fear of a "stronger US Dollar" unnerved Gold traders and investors? Because of the wording of the Press Release given out at the end of the FOMC meeting which concluded its deliberations on January 28. This is the now famous change of phrasing, from keeping policy accommodation going for a "considerable period" to being "patient in REMOVING policy accommodation".
The knee jerk analysis is this. The Fed is now actually considering RAISING US interest rates sooner than they had been considering them up until now. Hell, they might even raise them BEFORE the US elections in November. A rise, or even the threat of a rise, in US rates will have the inevitable effect of strengthening the Dollar. Better sell Gold (Silver, Platinum, Palladium, Oil, Euros, Pounds, Canadian Dollars, Aussie Dollars, Yen et al) NOW.
It is an undisputed fact that Comex Gold fell $US 16.10 (Silver was down $US 0.40) on Thursday, January 29, the day after that "momentous" Fed rewording of their boilerplate press release. That having happened, it behooves everyone to try and figure out WHY Gold fell out of bed. We here at The Privateer have been using what we call the "reverse barometer" for a long time in regard to sudden Gold selloffs. This measures the force and pressure of the financial and economic factors which should be forcing Gold up by the magnitude of a FALL in the Gold price. The fall is manufacured on the paper Gold markets, usually but not always the Comex.
Now, to consider these forces and pressures, consider four facts, all of which were reported in the days just before and just after the sudden Gold slump on January 29.
Fact one: On January 27, the day before the Fed completed their FOMC meeting and changed the wording on their press release, Japanese Finance Minister Sadakazu Tanigaki made a very telling statement. He said that his ministry will carefully consider whether to change the composition of its US$673.53 billion in forex reserves, including the weighting of gold in that total.
Why are the Japanese concerned about the composition of their forex reserves? The answer is contained in fact two: On January 30, it was reported that Japan spent 7.1545 TRILLION Yen ($US 67.6 Billion) in the period between December 27, 2003 and January 28, 2004 intervening in the foreign exchange markets. This was a record, beating the previous monthly record of 4.4573 TRILLION Yen by 60.5%. In the YEAR to December 27, 2003, Japan spent 20 TRILLION Yen supporting the Dollar. In the following MONTH, they spent 7.1545 TRILLION Yen, or 35.8% of the previous ANNUAL total. If the Japanese kept their rate of intervention up at its most recent level until December 27, 2004, their annual expenditure would come to 7.1545 TRILLION Yen times 12 months or 85.85 TRILLION Yen ($US 811 Billion at current exchange rates).
Do you see why Japan is considering whether to change the composition of its foreign reserves?
Now, here is fact three: The latest prediction from the Congressional Budget Office (CBO) is that US Federal defits will grow by a cumulative $US 1.9 TRILLION over the next decade. Five months ago, the prediction was for a cumulative deficit over the next decade of less than $US 900 Billion. The "projection" from the CBO has more than doubled in less than half a year.
Finally, here is fact four: The Bush administration now projects that the budget deficit for the year ending on September 30, 2004 will reach a record $US 520 Billion.
Japan spent 20 TRILLION Yen in 2003 supporting the US Dollar. In the first MONTH of 2004, they spent almost 40% of that total. Can they keep this up? Clearly the answer is no, and the first warning that they CANNOT keep it up has been given by Mr Tanigaki's public musings about the need to alter the mix of Japan's foreign reserves.
There is no end in sight to US borrowing and deficit spending. The Bush Administration itself now predicts that it will borrow $US 520 Billion this financial year to "run" the Federal government. Can they keep THIS up? Only for as long as the rest of the world is willing to buy their debt paper and ultimately their currency. It is well known that the Japanese have been the most "willing" nation when it comes to supporting the Dollar. But the Japanese are now starting to give out hints that they might have to back off.
Is there a replacement for Japan? The short answer is a succinct NO. For evidence of this, consider this quote from a Bloomberg report on January 28: "European Central Bank council members Klaus Liebscher and Nout Wellink signaled they see no need for the bank to stem the euro's appreciation with an interest-rate cut or currency sales. 'We haven't been and we aren't of the view that we should do something,' said Wellink, one of 18 rate setters at the ECB.
Many analysts looking at the Gold price fall of January 29 came to the conclusion that the main impetus was provided by the suspicion that the Fed might actually raise US rates sooner than had been anticipated. All these analyses took it for granted that such a rate rise would "boost" the Dollar on the foreign exchange markets.
In fact, it is likely to do precisely the opposite. US paper markets have been sanguine about the fall of the Dollar because they could see the rest of the world continue to buy US debt instruments and see Japan performing a labour of Hercules in the currency markets to prevent the Dollar from falling "too fast". It has been this complacency which has allowed the Fed to sell the outlook that they could keep rates at their present 1.0% for the famous "considerable period". By the way, the Fed Funds rate has been at its present 1.0% level for a little over seven months - since June 25, 2003.
A rate RISE by the Fed would be a red light signal that the rest of the world is no longer able and/or willing to keep buying US debt paper and US Dollars at a pace sufficient to fund the US trade/current account/federal deficits and keep the fall of the Dollar "orderly". It would be the first step of the US transforming itself into "just another country" in financial/fiscal terms.
Remember what any ordinary country has to do when their credit expansion and bubble markets become too big to "manage". They have to either raise rates rapidly or step out of the way and let the market determine rates, in which case they usually rise even more rapidly. And, to defend their currency, they have to drastically curtail both their bank lending and their government borrowing. This is known in popular parlance as a "financial crisis".
Such a thing could never happen to the US, could it? Well, a Fed rate rise would be a signal that is IS happening, a signal that NO ONE could ignore.
The Gold price dive of January 29, when viewed in light of the facts we have enumerated above, is a HUGE warning that the pressures and imbalances which have been building up in the global financial system are coming to a head. Next week (Feb 6-7), and in full knowledge of just how huge the pressures are, the G-7 meets in Florida. It should be a real bun fight, behind closed doors of course.
Gold briefly dipped back under $US 400 on January 29 and then staged a small rebound to close at $US 402.20 on Friday January 30 in New York. The "interpretation" that the fall was caused by an immenent strengthening of the US Dollar has been sold to many. It will likely hold in the lead up to the G-7 meeting. We don't think it will hold for too long after the meeting. Stay tuned.