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Expected moves of the world leaders
gathered at the Group of 20 meeting in Pittsburgh this week to rebalance the
world economy in favour of Asian countries, particularly China, is widely
expected to erode the dollar’s dominant role and possibly one of the
main causes putting the dollar under pressure lately.
In this respect, it should be noted that there is a big difference between
what China is saying on the dollar and what their real policy is.
Most important to conclude is that a
declining dollar would have a negative impact on China’s enormous pile
of foreign-exchange reserves of $ 2.1 billion, representing more than 75% of
its total foreign reserve and built up in a period of just seven years from
trade balance surpluses. This easily acquired money protected the Chinese
from being one of the victims of the financial and credibility crisis, which
actually only applies to the western world, and Japan.
Since September last year when Lehman
Brothers collapsed, the western world had to bail out its banks for huge
rescue packages of approximately $ 2,000 billion before global stimulus
packages of about $ 2,500 billion, including China’s $ 586 billion
stimulus package, could contribute to the worldwide economy’s
recovering since last April.
Rebalancing the global economy would
allow for a stronger yuan over time, but financial experts agree that it will
take at least ten years before the yuan could be a currency of global
importance. In this respect, the effect of China having started to sell bonds
denominated in yuan on the global financial markets as a threat to the
dominant role of the dollar, is strongly overstated in the media.
Recognizing that the 6 billion yuan ($
879 million) worth issue of Chinese government bonds in Hong Kong, is a major
step to internationalize its currency, promoting the yuan in neighbouring
countries and improve its international status, it is just a minor step from
a global point of view not having any direct impact on the status of the
dollar’s key role in the international financial markets.
As a matter of fact the Fed can allow
keeping US interest rates down to almost zero percent and is nevertheless
successful with the current US Treasury Securities auctions. Investors
outside the United States have bought 43% of the $ 1.41 trillion worth of
notes and bonds sold by the Treasury department this year, compared with 27%
of the $ 527 billion issued at this point in 2008.
Noteworthy in this respect is that the
15% decline of the trade-weighted US dollar index from its high this year on
March 4, has proved no obstacle in treasury auctions. This actually
means that the financial world, including the Chinese, strongly believes that
their money is safe in the United States, with expectations for inflation, as
measured by inflation-indexed bonds, below the 5-year average.
Just to illustrate the difference on
what China is saying and how it is acting in the financial markets, is China
having added $ 24.1 billion to its reserves in Treasury securities in July,
raising its stake in US government debt to $ 800 billion, after net
sales of $ 251 billion in June.
It should be recognised that China has become an active trader in the financial markets as it already is in the
commodity markets or some time.
Most striking is that while the
trade-weighted US dollar index declined 15% since its high this year on March
4, particularly reflecting the decline against the euro and Japanese yen, the
dollar remained stable against the yuan at around 6.84 yuan for one dollar,
actually improving China’s competitiveness against the Euro zone and
Japan.
This illustrates once more that the
Chinese are master players in their strategy how to pass the hegemony of the United States in the smartest way.
Becoming top carry-trade currency
negative for dollar
The big question is what is really
moving the dollar since its decline is not related to a breach in confidence
in the current economic recovery in the United States and at the same time
the recovery of the Euro zone and Japan, to justify their currencies being
stronger. Also the Fed interest rate close to zero, compared with the ECB rate
of 1% is not really a factor of importance.
What remains as the most obvious
reason for the weakness of the dollar is that it has become a top carry-trade
currency, like the Japanese yen has been for years, because of extreme low
short-term interest rates.
With little sign that the United
States is set to withdraw from its ultra-loose monetary policy any soon to
support the country’s economic recovery it is attractive to sell
low-yielding dollars, to finance the purchase of riskier higher yield assets,
particularly in commodity rich countries like Australia and Canada. This
strategy was widely used in the years prior to the eruption of the financial
crisis.
Since the beginning of September, the
dollar weakened against the euro from $ 1.42 for one euro compared with
currently $ 1.48 for at one dollar and the US dollar index at falling back
under its long-term resistance level of 80.
However, apart from a relatively small
decline of $ 0.06 or 4% against the euro, the dollar is still trading at a
comparable level back to the end of 2007. This is well before the outbreak of
the financial crisis, which didn’t affect the dollar only, but also
underpinned its status as a safe haven in turbulent times and outperformed
gold.
Gold price not going up for fundamental
reasons
By saying so, one should have at least
mixed feelings about the gold price having benefited from the weakness of the
dollar, for the wrong reasons, and having created a sentiment of self
fulfilling prophesy being driven by a strong growth of speculative long
positions on the COMEX.
A comparable situation was created
earlier in 2008, when the gold price reached an all time high of $ 1,030.80
on March 17, followed by a 33% decline to a low of $ 692.50 on October 24. In
the meantime, the gold price showed several strong fluctuations up and down
making it a trading vehicle rather than a safe haven, protecting investors in
a period of economic financial turbulence, which it did not.
Actually, gold is showing a
controversial trend by going up, since the worst of the crisis is over and
market watchers are looking for other options to justify the current strength
of gold to continue.
Fear for inflation premature
The fear for growing inflation appears
to be the main concern now and supposed to support higher gold prices, I will
probably take at least another year before the world economy has fully
recuperated.
Also the impact of the bail-out and
stimulus packages on money supply are not that high inflationary as also most
experts think. This is because the deflationary impact of the real economy
related crash on the world equity markets is many times bigger. The
MSCI-world index lost about 50% or $ 31,000 billion of its value in the
period of 2008 and the first two months of 2009.
Compared with the rescue and stimulus
packages of $ 2,000 and $ 2,500 billion, respectively, it should be clear
that the size of the packages as such is not big enough to save the world
economy, but that the recovery on the world equity markets by 25% or
approximately $ 8,000 billion is actually the driver of the improved
sentiment.
In summary, having said in my
August-issue that the shorter than expected recession holds gold back from
the $ 1,000 barrier, this view was and is still based on fundamental factors
rather than on speculation in the dollar as a carry-trade currency and
speculation on the COMEX.
With volatility in gold trading having
become common without being directed from a fundamental point of view, this
implicates that as an independent fundamental gold analyst, I prefer not to
join the big crowd of opportunistic gold market watchers, including the
captains of the gold industry and experts from the professional investment
community, who preach to the converted.
Barrick closing its remaining gold
hedges driver of gold price
It is noteworthy to see that gold
producers have accelerated the process of buying back their hedges in the
last few years, particularly since the gold price passed a critical level of
$ 600 in 2006, with operating margins for major gold producers at
approximately 50% and to come under strong pressure due to delivery
commitments under hedging contracts.
The most illustrative example is Barrick
Gold, the world’s largest gold producer, having recently announced
that it will close its remaining gold hedges at a cost of $ 1.9 billion over
the next year.
This announcement together with the
dollar having become a carry trade currency, probably have been the real
driving force behind gold’s move above $ 1,000 rather than improving
fundamentals based on supply and demand.
Barrick had 5.4 million ounces of
fixed-price contracts at the end of June of which 3.0 million ounces having
remained as per the second week of September.
The 2.4 million ounces that it therefore dehedged from July is the equivalent
to a sixth of global mine production in that period, which has been bullish
for the gold price.
As of the end of the second quarter,
the global hedge book was at 14.7 million ounces, down from the peak of 103
million ounces in the third quarter of 2001, with major gold producers having
almost closed their hedge books, which is negative for gold.
With Barrick now closing its hedge
book at a gold price around $ 1,000 and probably being responsible for at
least a part of gold’s recent price rise of $ 50 at their own expense,
I have my doubts on the Company’s strategic vision to optimize its
profits.
Barrick has three large projects under
construction; Cortez Hills in Nevada, Viejo in the Dominican
Republic and the Pascua-Lama Project, spanning the border of Argentina
and Chile, which together with the Buzwagi Project in
Tanzania, having poured its first gold in early May of this year, will
contribute barely 2.6 million ounces of lower cost production, once at full
capacity, to the 7.66 million ounces of gold produced in 2008.
These new mines, with the exception of
Cortez Hills, are developed at significantly lower cash costs than
Barrick’s total 2008 cash costs at a full credit basis for non-gold
sales at $ 337 per ounce. At a price of $ 1,000 plus, Barrick could hedge a
part of its future new production to secure at least a $ 600 or 60% margin,
which is substantially higher than the current margin and could have a
stabilizing effect on the Company’s profits this year.
Marino G. Pieterse
Editor, Gold Letter International
Marino G. Pieterse has
been an independent financial analyst and gold specialist for more than 25
years. He is the chief-editor of Goldletter International, the only gold
investment market letter in English in Europe focusing on emerging gold
regions in the world, as well as reports on individually featured companies
and special reports on other metals, including uranium. You can receive Gold
Letter International’s reports for free by clicking on the
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