"NGold futures on the Comex division of the New York Mercantile Exchange buckled over 2% Tuesday on fund and bullion bank selling spurred by the firmer posture of the U.S. dollar ahead of Wednesday's Federal Reserve decision on interest rates."
OsterDowJones Report On Comex Gold Trading - June 29, 2004
"We see the upside for gold prices capped at $ 410/oz, but with robust support at $ 380/oz becoming increasingly vulnerable as the year continues in line with tighter monetary policy and a firmer dollar, at least against the Euro."
A Gold "expert" from Barclay's Capital - June 29, 2004
In the lead up to and the immediate aftermath of the Fed's decision to hike their Funds rate by 0.25% to 1.25% on June 30, there were countless variations of this theme wafting across the internet from all points on the compass of "mainstream" economic and financial analysis. The overwhelming consensus was - and in large part still is - that "tighter money policy" (read higher interest rates) would bring with it in lock step a stronger US Dollar.
On June 29, the day before the Fed made its announcement, the spot future $US index closed at 89.70 points. By the end of the week on July 2, the $US index had fallen to close at 88.18. This close of 88.18 was the lowest spot future close on the index since April 1 - the day when spot future Gold closed at its 2004 high to date of $US 427.80. Of the major components in the $US index, the Dollar fell by far the most against the Euro - see the quote above.
"They are unanimous in their outlook that higher interest rates will strengthen the US Dollar and the more aggressive the Fed is in lifting rates, the stronger the Dollar will become. Of course, according to the dealers, the flip side is that as the Dollar strengthens, the $US Gold price will weaken. ...The markets are primed for a knee jerk reaction in which the Dollar goes higher (and Gold maybe goes a little lower) in the short term. Even if that does happen, it won't last."
Gold This Week - June 25
Leaving aside the obligatory Gold "hit" (Comex spot future Gold fell $US 8.50 on June 29), the "knee jerk" reaction towards a higher US Dollar has not happened at all - at least not so far. Intead, the US Dollar has promptly fallen to three month lows on the $US index. Gold, since the Fed announcement on June 30, has spent the rest of the week getting back $US 5.90 - about 70% - of its June 29 fall.
Please note, in this regard, that the European Central Bank (ECB) met on July 1, the day after the Fed announced higher US rates and left European interest rates alone at 2.00%. The differential between US and European rates has therefore narrowed from 1.00% (US 1.00% - EU 2.00%) to 0.75% (US 1.25% - EU 2.00%). No matter, on July 2, the Euro jumped $US 0.014 to $US 1.2320 - equalling its highest level since March 23.
The ECB meets to discuss their controlling rates every two weeks and has a press conference after every second meeting. These are the meetings at which rate adjustments are most often made. The next such ECB meeting will be on July 29. The FOMC next meets on August 10. We would be surprised if the ECB waits until after the next FOMC meeting before raising their own rates.
The almost universal expectation that the US rate rise would result in a "stronger" US Dollar was and is a source of awe and amazement to the many fine financial analysts and economists who are NOT part of the "mainstream". They are not blind to the present debt situation of the US. Nor are they entirely ignorant of economic history. Examine ANY currency crisis of the past thirty years. In fact, one doesn't have to go back that far. Examine what happened during the Asian economic crisis of the late 1990s. As the currencies of the smaller nations most affected by the crisis (Thailand, Indonesia, The Phillipines, Malaysia, etc) plummeted, their interest rates soared.
In a global "fiat" money system, climbing MARKET interest rates are ALWAYS a certain indicator of a rising LACK of confidence in the currency of the nation in which the rates are rising. A climb in OFFICIAL interest rates is ALWAYS a certain indicator that the monetary powers that be (the government Treasury and Central Bank) have run out of ways to reassure or "jawbone" the international market as to the underlying "strength" of their economy and balance sheet. As such, higher official rates are always a sign that economic and financial reality have caught up with the financial authorities, leaving them no choice but to act.
This is the case whether the nation in question is Upper Volta, or Brazil, or Indonesia, or the United States of America. Given similar economic and financial policies, the only difference is that the more powerful and essential the nation is to the global system, the longer it can get away with defying economic and financial reality. The US has been getting away with it for decades, far longer than any other nation.
There is no competent financial/economic analyst anywhere in the world (we stress, anywhere in the world - INCLUDING the USA) who does not know that the borrowing and spending practices of the US has depended solely on the "willingness" (coerced or voluntary) of the rest of the world to go on buying and HOLDING US debt paper of all varieties, but mainly US Treasury debt paper. There is no competent analyst who does not know that the "demand" for this $US debt from the private sector dried up last year and that for most of the past year, almost the sole buyers of the paper have been foreign (notably Asian) Central Banks.
Knowing this, it is not "rocket science" to draw the conclusion that these Central Banks know that the only thing standing in the breach and preventing (or at least postponing) a $US collapse of potentially catastrophic proportions was their buying of this debt. The Fed knows this too, of course.
On July 2, Mr Koichi Hosokawa took over as the top "career" financial official at the Japanese Ministry of Finance. On taking office, Mr Hosokawa was quoted as saying: "Foreign exchange rates should reflect economic fundamentals and 'excessive and disorderly movements of currencies' are undesirable for economic growth. We will take appropriate action as needed, based on our stance that foreign exchange rates should move in a stable manner."
In Japan, the Central Bank - the Bank of Japan (BoJ) - intervenes in the foreign exchange markets at the "behest" (read at the command) of the Ministry of Finance. The BoJ has just announced that between March 16 and "at least" June 28, they sold ZERO Yen in these markets. In the period between the start of 2004 and March 16, the BoJ sold 10.7 TRILLION Yen. IN 2003, they sold 20 TRILLION Yen. Since March 16, they have "officially" sold ZERO Yen.
We must stress here that this is the OFFICIAL line from the BoJ. It may or may not be true. We can, however, state with some confidence that even if the BoJ has not entirely ceased selling Yen for US Dollars to support the Dollar, they have certainly curtailed their selling to a significant degree. The evidence for this is the huge acceleration in the US money supply numbers which took place over the period during which the BoJ pulled in its horns. Somebody had to buy the debt paper and the only way to keep rates down (to the extent they have been kept down) is for the buying to come from an "official" source. That official source was the Fed.
The acceleration of the money supply numbers in the US have recently ground to a halt. Over the week ended June 21, US M-3 actually declined by $US 10.5 Billion, even though its year to date expansion still comes to 10.1% annualised. On top of that, the latest US new job creation figures for June totalled 112,000, less than half the expected 250,000. And, of course, both government deficit spending and the US current account deficit continue to set records.
In sum, the distortions have reached the point where no amount of "jawboning" or painting of "rosy scenarios" is sufficient to "calm" market nerves. The Fed had no choice and knew it had no choice. It thus began a process months ago which has now culminated with the most "telegraphed" US rate rise in history.
Between June 11 and June 25, Gold recorded a significant rise in $US terms and, more important, Gold rose in terms of EVERY major global currency (see Gold This Week - June 25). On the day before the FOMC announcement, Gold was duly pushed back below the $US 400 level, falling $Us 8.50 on the day. This week, Gold has lost a bit of ground in $US terms and more ground in terms of other major currencies due to the marked weakness in the $US in the wake of the rate announcement.
None of the "problems" have gone away. All that has happened is that the Fed has been forced to acknowledge them by raising its official rates. This rate rise will not "solve" anything. It will merely bring the problem to the attention of more people and make the job of the "mainstream" analysts more difficult. Most important of all in the context of Gold is the fact, oft repeated on these pages, that RISING official rates and FALLING currencies go hand in hand. Don't fight the Fed - they are telling you that the situation is getting too hard for them to handle.