August 14th, 2008

London View on Gold and FX

However, confidence in this defensive strategy has been shaken since July 15 as gold and silver (SLV and GLD), Euro (FXE), Pound (FXB), Yen (FXY) tanked and the stock market rallied (S&P 500). Note also that the collapse of financial stocks was halted (temporarily?) and a sharp recovery began. But the bounce seems to be petering out as the individual stocks and the Financials ETF hit a descending the wall of a 60-day moving average. What brought all this on was the Fed’s decision to bail out Freddie and Fanny. But enough history. The think we should be caring about is what might happen in the future and what should be our strategy.

I attended another session of the New York Investing Meetup Group in Manhattan last night. If you aren’t in commuting distance or weren’t aware of the group before, you can catch up the proceedings since Daryl Montgomery, the groups founder and principal presenter, posts most of the presentations on the groups website. In addition, Daryl offers some videos of previous presentations hosted on youTube. Daryl also writes about economic matters at The Helicopter Economics Investing Guide.

One of Daryl’s recurring themes since the sub-prime crises emerged last August has been the inaccurate media or biased reporting, prospect of significant inflation on the horizon (“government statistics aren’t accurate and intentionally untrue”), facts concerning the financial system collapse and protections potentially available through foreign currencies, gold and silver.

While researching what others have to say about these events, I ran across an extremely enlightening article appearing in the Telegraph of London by Ambrose Evans-Pritchard entitled “Stage two of the gold bull market is just beginning (by the way, if you’re like me and have never read this blog before then do so now. His articles shed light on what’s happening globally – something that affects here in the US but don’t read much about in our press). Here are some of his main points:

“we reached the moment when gold bugs must start questioning their deepest assumptions. Have they bought too deeply into the “dollar-collapse/M3 monetary bubble” tale, ignoring all the other moving parts in the complex global system? Nobody wants to be left holding the bag all the way down to the bottom of the slide, long after the hedge funds have sold out.

Well, my own view is that gold bugs should start looking very closely at something else: the implosion of Europe. (Japan is in recession too)…….

The rift between North and South was not enough to fracture the system in the first post-EMU downturn, the dotcom bust. We have moved a long way since then. The Club Med bloc is now massively dependent on capital inflows from North Europe to plug their current account gaps: Spain (10pc), Portugal (10pc), Greece (14pc). UBS warned that these flows are no longer forthcoming.

The central banks of Asia, the Mid-East, and Russia have been parking a chunk of their $6 trillion reserves in European bonds on the assumption that the euro can serve as a twin pillar of the global monetary system alongside the dollar. But the euro is nothing like the dollar. It has no European government, tax, or social security system to back it up. Each member country is sovereign, each fiercely proud, answering to its own ancient rythms……

What we are about to see is a race to the bottom by the world’s major currencies as each tries to devalue against others in a beggar-thy-neighbour policy to shore up exports, or indeed simply because they have to cut rates frantically to stave off the consequences of debt-deleveraging and the risk of an outright Slump.

When that happens – if it is not already happening – it will become clear that the both pillars of the global monetary system are unstable, infested with the dry rot of excess debt……

Gold bugs, you ain’t seen nothing yet. Gold at $800 looks like a bargain in the new world currency disorder.”

The markets will sober up from the false positive reactions to the Fannie and Freddie bailout on July 14. The charts seem to be indicating that the financials will resume their retreat (some don’t have too far left to go before they hit zero). But this time their going to be joined by the big players who seem to have been somewhat immunized from the effects of the collapse. Specifically, Goldman Sachs (GS)and JPMorgan (JPM). More on that later.

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