Gold Knows What No One Knows!

By: Gary Dorsch | Mon, Apr 10, 2006
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April Fools day usually arrives on April 1st, but the day for the European Central Bank chief Jean "Tricky" Trichet, to play dirty tricks came on April 6th, and left over zealous Euro bulls licking their wounds. Expectations of an ECB rate hike to 2.75% on May 4th, seems like a slam dunk, with the Euro M3 money supply exploding at an annualized rate of 8% in February, way above the ECB's 4.5% reference level for stable inflation, and European bank loans to the private sector expanding at a 10.3% clip, the fastest rate in over six years.

Such a potent cocktail is fueling takeover mania across Europe, where mergers and buyouts doubled to $454 billion in the first quarter from the same period a year earlier, after a whopping $1.03 trillion of deals in 2005. "Tricky" Trichet and his cohorts at the ECB are holding down borrowing costs in the Euro zone by expanding the Euro money supply to meet strong loan demand, in a brazen effort to lift European stock and real estate markets higher.

With demand for cheap long-term credit rising strongly in Germany, questions must be asked about whether the low level of global interest rates are appropriate, said the future ECB chief economist Juergen Stark on March 28th. "We are dealing with a global wave of liquidity today. One must ask oneself whether key interest rates are sending the correct signal here. This development is unsustainable," he said.

Other ECB policymakers were barking loudly last week whipping the Euro bulls into a buying frenzy. "There are risks to price stability and among those are second-round effects," said Spain's central banker Jose Manuel Gonzalez-Paramo. "The ECB is concerned principally about price stability, and if monetary aggregates showed dynamic growth and if asset prices rise, that would be a concern," he said.

Luxembourg central bank governor Yves Mersch was more explicit, and indicated that the ECB's work was not done. "Where we still have to walk the talk is to deliver on price stability to bring about inflation that is close to but below 2 percent. That is also part of walking the talk, to be faithful to what we say," he said.

But when the moment of truth arrived for the ECB to walk the talk on April 6th, "Tricky" Trichet pulled the rug from under the Euro, and in the process, created a lot of ill will towards the 12-nation common currency. "The present high probability which is given for an increase of rates in our next meeting does not correspond to the present sentiment of the Governing Council," sending the Euro tumbling against the US and Canadian dollars and the British pound.

But the gold market remained defiant, hovering just below 500 Euros per ounce, even after global bond yields moved swiftly higher. Euro traders are learning the hard way, what gold traders have known to be true for quite some time. Central bankers can not be trusted to preserve the purchasing power of paper money. Gold knows what no one knows!

Explosive Euro M3 money supply combined with double digit Euro loan growth calls for immediate rate hikes on the order of a half-percent. However, at his April Fools Day press conference, Trichet said the ECB would not be bullied by futures traders on the Frankfurt Eurex who were pricing in a 100% probability of a quarter-point ECB rate in May. Instead, Trichet will stick to a snail's pace of lifting rates in baby steps every three months.

Trichet indicated that a handful of economic reports, such as a large 0.5% jump in Euro zone producer prices in March to an annualized 5.4% rate, were certainly no reason for the bank's Governing Council to rush into action. Instead, the ECB wants to remain comfortably behind the inflation curve to stimulate corporate profits, and prevent an unraveling the EuroStoxx-600 rally that it worked so hard to engineer.

Trichet's endless brainwashing about his self-proclaimed vigilance against inflation falls on deaf ears in the gold market these days. "We are still, and will continue to be credible, as we were at the first day," he told leading bankers at the Institute of International Finance on March 30th. "Our anchoring of inflationary expectations remain impeccable because markets know we are very, very serious when we are speaking of preserving and maintaining price stability," he said, even as gold moved in on 500 Euros /oz, and is up 48% against the Euro from a year ago.

But Trichet's audience is the investment banking community which is reaping huge profits from merger mania in Europe, which in turn, needs the daily injection of cheap money to keep business executives in the mood to buy other companies. European exporters prefer a weaker Euro, so the ECB is aiming for a sweet spot of $1.20, which can keep foreign sales buoyant to the Far East and the US, yet help to hold down the cost of dollar denominated raw material and crude oil imports.

European gold traders were a bit slow to recognize Trichet's strategy, but finally saw through the smokescreens in September 2005, when the Euro M3 money supply expanded at an 8.5% clip, without a protest from the vigilant Trichet. Jawboning and stepped up gold sales in the fourth quarter of 2005 failed to keep the yellow metal under sedation, cornering "Tricky" Trichet, and forcing the ECB into two baby step rate hikes to 2.50 percent.

Now, the ECB faces a dilemma, because the gold market in Europe has become more sophisticated, and is pegging the gold price to the performance of leading Euro equity markets. So unless the ECB steps up to the plate to tighten its monetary policy, neither gold nor EuroStoxx blue chips are likely to give up much ground. And according to Trichet, the ECB wants to stick to its three month timetable of raising rates, and refuses to be bullied into a faster track, like the Federal Reserve.

Across the English Channel, the bankers on Thread-Needle Street make the ECB look like monetary hawks. The Bank of England became the first disciple of former Fed chief Alan Greenspan's "Asset Targeting" policy in 2001, when it slashed its base rate to 3.50%, in a desperate effort to cushion the decline of the Footsie-100. Either by design or fanciful luck, the BOE succeeded in doubling UK home prices, helping the British economy to avoid a recession that gripped the Euro zone and the US.

The Bank of England has opened wide the money spigots, fueling asset inflation in the UK equities markets and in gold. Housing prices have begun to percolate again, rising for six consecutive months to stand 5.3% higher from a year ago. With its manufacturing base moving overseas and dwindling oil supplies from the North Sea, the UK economy hinges on asset inflation, much like the US economy.

Official data on March 20 th showed UK government spending and borrowing at the highest levels since Labor took power in 1997, with a 37 billion pound shortfall for public sector net borrowing projected for the fiscal year ending April. UK Exchequer chief Gordon Brown requires a 2.0-2.5% growth rate for this year and 2.75-3.25% for 2007 to meet his budget targets.

The Bank of England is accommodating the UK Treasury's loan demands by expanding its M4 money supply 12.2% from a year ago, and keeping borrowing costs low to prevent a downturn in UK home prices. British traders turned to gold after the BOE lowered its base rate to 4.50% in August 2005, when it became obvious that the BOE's jawboning about fighting inflation was just empty words.

On February 24th, 2005, the Bank of England's Rachel Lomax predicted inflation would rise above its 2% target and while there "almost always is a case for waiting to raise interest rates, we need to be pre-emptive against inflation. Any weakness in consumer spending is likely to be temporary. There is very little slack in the UK economy," suggesting that growth would feed through to faster inflation.

But a BOE rate hike never materialized. Instead, the UK central bank lowered its base rate six months later in August 2005, to prevent a downturn in British home prices and consumer spending. That triggered a gold rally from 220 pounds to 340 pounds per ounce, and natural resource and oil stocks led the Footsie-100 above the psychological 600-mark. Super easy money in the UK has also nurtured $350 billion of takeover deals over the past 15-months, much to the delight of UK bankers.

The Bank of England has never really understood the psychology of the gold market. The BOE dumped two-thirds of its gold, or 415 tons, between 1999 and 2001 at an average price below $300 per ounce. But what is more surprising, the gnomes of Zurich, stationed at the Swiss National Bank made the same blunder, by selling half of the Swiss gold reserves, or 1300 tons, between May 2000 and May 2005.

Overall, the SNB gold sales amounted to 21.1 billion Swiss francs, at an average selling price of $351.40 per ounce. Soon after the SNB's final gold sale in May 2005, the price of gold climbed by nearly 50% over the next eleven months to 760 francs per ounce, to reflect a 50% loss of gold behind the Swiss currency. The collapse of the Swiss franc in relation to gold, puts into question the psychological status of the Swiss franc as a safe haven currency.

The SNB lifted its target band for the three-month Swiss franc Libor rate to 0.75% to 1.75% from 0.50% to 1.50% on March 16th, its second rate hike in three months, aiming for the mid-point 1.25%, within the new target band. The SNB is following the lead of ECB, with both banks sticking to three month intervals between rate hikes, to keep the Euro /Swiss franc exchange rate in a stable range.

The SNB will tighten rates gradually, said SNB member Philipp Hildebrand on March 23rd. "The fact is that from today's point of view we are in a situation to conduct a cautious approximation of rates towards neutrality, thanks to a favorable inflationary development and still well-anchored inflationary expectations," said Hildebrand, attempting to brainwash the financial media while ignoring the 50% devaluation of the Swiss franc versus gold.

"If the economic development continues as expected, the SNB will continue its adjustment of the monetary policy course gradually so that price stability is insured in the medium term. Even after raising the target band of the three-month franc Libor by 25 basis points the National Bank supports the upswing," Hildebrand noted.

However, the Swiss franc will remain a low interest rate currency that hedge funds can utilize for funding operations in gold, silver, crude oil, copper, and zinc, the premier leaders of the "Commodity Super Cycle".

In the Far East, the Bank of Japan announced on March 9th that is would begin to dismantle to ultra easy money policy, by draining 26 trillion yen ($220 billion) from the Tokyo money markets in the months ahead. But nobody knows for sure what time frame the BOJ has planned to lift its overnight loan rate above zero percent. Instead, BOJ chief Fukui has gone out of his way to assure Japan's financial warlords of the ruling LDP party, that BOJ policy would remain accommodative.

On March 22nd, Fukui said, "It'll take several months to finish absorbing current account deposits. We don't plan to cut the amount of outright JGB buying immediately after those several months." The BOJ buys 1.2 trillion yen ($10 billion) in long-term JGB's outright from the market per month. So while the BOJ is draining yen by refusing to rollover maturing short-term debt, it is also pumping 1.2 trillion yen into the banking system each month through JGB purchases.

Japanese Finance Minister Sadakazu Tanigaki warned that the recent rises in long-term interest rates could damage the economy, adding the Japanese economy is still in mild inflation. Asian Development Bank President Haruhiko Kuroda urged the BOJ to be "cautious" about further interest rate increases. "Although the economy has recovered very strongly, the price situation has not changed much, so I think the BOJ would be very careful and cautious in executing its monetary policy."

Tanigaki said Asian and European financial chiefs meeting in Vienna on April 9th, were concerned that credit tightening in advanced countries could hurt the world economy. "Many of them share the outlook that global growth will continue amid low inflation," he said. But the financial officials "consider high crude oil prices, rising interest rates in advanced economies, global current-account imbalances and bird flu to be risk factors," he said.

So the Bank of Japan remains under heavy political pressure to go slow with its tightening campaign, and to keep yen plentiful and cheap, insulating the Japanese economy and Nikkei-225 stock index from record high oil prices. Japanese gold traders understand the scheme that LDP financial warlords are pursuing, and are pegging the price of gold to the Nikkei-225, both rivals for investment funds seeking a safe haven from BOJ monetary inflation.

After hiking the fed funds rate to 4.75% on March 28th, the Federal Reserve acknowledged that the "Commodity Super Cycle" might be signaling higher inflation. "Possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures," the FOMC said. Engaging in a battle with the "Commodity Super Cycle" would represent a 180 degree turn in Bernanke's thinking on commodity prices and inflation.

On February 5th, 2004, Bernanke said "rising commodity prices are a variable of growth rather than inflation." As for soaring energy prices, "while a sudden shock may cause oil prices to rise, there is an equally good chance that oil prices might go down over the next couple of years. Barring some kind of major shock, I personally don't find the energy issue crucial to the recovery. I don't expect inflation at the core level to rise significantly this year or even in 2005," Bernanke said.

Then on May 24, 2005, Bernanke again played down worries about higher energy and commodity prices. "Much of the recent price gains in energy and commodities reflect the rapid growth of the Chinese economy. Chinese authorities are now trying to slow that growth, and should help check the growth of commodity prices."

On October 25th, 2005, the newly appointed Fed chief Bernanke said that there was little reason to fear that the sharp rise in energy prices would feed through into wider inflation. "The evidence seems to be that it is primarily in energy and some raw materials and has not fed into broader inflation measures or expectations. My anticipation is that's the way it's going to stay."

But the Federal Reserve is almost out of ammunition in its 21-month old battle against gold, silver, copper, zinc, and crude oil, the premier leaders of the "Commodity Super Cycle." Sales of new US homes had the biggest monthly decline in almost nine years in February and the number of properties on the market rose, evidence the housing bubble is deflating after a five-year boom.

New US home sales fell 10.5% to an annual rate of 1.08 million, the lowest since May 2003, from a revised 1.207 million in January. The number of homes for sale rose to a record 548,000 from January's 525,000. At the current sales pace, there were enough new homes on the market to satisfy demand for the next 6.3 months, the largest amount in more than a decade. The median selling price of a new home last month was $230,400, from $243,900 in October.

A gauge of US mortgage applications fell to the lowest level of the year as home purchases and refinancing declined. But the Federal Reserve is not about to pull any nasty tricks like Jean Trichet, and should follow through on its widely telegraphed quarter-point rate hike to 5.0% on May 10th. But beyond 5.0%, the Fed would risk killing the goose that lays the golden eggs for the US economy, the housing bubble, and that might be a red line that Bernanke & Company cannot cross.

If correct, which central bank would assume the mantle of fighting gold, silver, crude oil and commodities rallies with a tighter monetary policy? European and Japanese central banks are playing a double game, tightening monetary policy at a snail's pace, but leaving plenty of Euros and yen floating in the banking system at negative real interest rates, in an effort to keep their equity markets afloat.

Memories of the Enron and Worldcom scandals are fading into the distant past, but there was a time when Congress demanded greater transparency of accounting records. But with a slight of hand, the Federal Reserve, under the leadership of Ben Bernanke announced on November 10th, 2005, that it would no longer disclose to Americans what it is doing with the US M3 money supply. Since then, gold has soared $110 per ounce, bumping against the psychological $600 level.

So while the Dow Jones Industrials rally to 5-year high might look impressive in US dollar terms, the DJI is in a raging bear market in hard money terms. Last week, the DJI fell below 19 ounces of gold, or 30% lower than two years ago. Over the past 6-months, the DJI has plunged by 50% in silver ounces per share. Without the honest transparency of M3 reporting, all major US assets should be measured in terms of gold ounces, a de-facto gold standard.

But while gold is matching the performances of European and Japanese equity benchmarks, and blowing away the Dow Industrials, the yellow metal is still in a four year bear market against the crude oil market. Gold has rebounded from as low as 6.5 barrel of crude oil per ounce, but meeting resistance at 9.25 barrels this year. Gold might outperform crude oil, if Arab oil kingdoms in the Persian Gulf decide to allocate more Petro-dollars to gold, in a flight to safety from the Ayatollah of Iran.

Countries close to Iran, including Kuwait and the United Arab Emirates, are focused on Iran's nuclear weapons program, which "still poses a big worry," said Sheik Abdullah bin Zayed Al Nayyan, the foreign minister of the United Arab Emirates on March 22 nd. Iran's first nuclear reactor is expected to go online this year, in Bushehr in southern Iran, just 150 miles across the Persian Gulf from Kuwait.

Iran is seismically unstable, and an earthquake could cause an accident that would be more disastrous for Gulf countries than for Iran. "A catastrophe that kills 200,000 people could mean wiping out half of Bahrain," Al Nayyan noted. In addition, any pollution of the Gulf would shut down the six water desalination plants on the Arab shore. A possible military confrontation between Iran and the US could trigger Shiite-Sunni sectarian tensions across the region.

Yahya Rahim Safavi, commander-in-chief of the Iranian National Guards, was speaking to state television on April 5th, during a week of naval war games in which Tehran announced the successful testing of new weapons, including missiles and torpedoes. "The Americans should accept Iran as a great regional power and they should know that sanctions and military threats are going to be against their interests and against the interests of some European countries," he said.

"We regard the presence of America in Iraq, Afghanistan and the Persian Gulf as a threat, and we recommend they do not move towards threatening Iran," Safavi said. Iran has a commanding position on the north coast of the Strait of Hormuz, and could still disrupt shipping of two-fifths of the world's globally traded oil, or 17 million barrels per day, that passes through the narrow Strait of Hormuz.

The Washington Post said April 9th, no US military attack appears likely in the short term, but Pentagon officials are preparing for a possible military option and using the threat to convince Iranians of the seriousness of their intentions. Pentagon and CIA planners have been exploring possible targets, such as Iran's underground uranium enrichment facility at Natanz and its uranium conversion plant at Isfahan, both located in central Iran, the report said.

Iran is not about to be cowed by planted stories in the media. It sounds like the boy crying Wolf. "We regard that planning for air strikes as psychological warfare stemming from America's anger and helplessness," replied foreign ministry spokesman Hamid Reza Asefi. "Sending our file to the UN Security Council will not make us retreat. During the past 27 years, we underwent economic sanctions and in spite of that we made economic, technical and scientific progress," he added.

The Ayatollah Khameni has bought the Chinese and Russian vetoes of any credible UN sanctions against Iran, with multi-billion dollar arms deals, construction deals for nuclear sites, and is dangling a $100 billion deal for development rights of the Yardavan oil fields before Beijing. Without the credible threat of economic sanctions against Iran, the world would either witness a nasty military confrontation in the Persian Gulf or a nuclear armed Iran in the months or years ahead.

The Ayatollahs drive for nuclear invincibility appears to be unstoppable, short of military action. Diplomacy could drag on for a few more months, to convince a skeptical public that all measures to avoid war were exhausted. But Beijing and Moscow are expected to continue blocking the UN from tough sanctions against Iran, effectively closing the door for a diplomatic solution.

Venezuela 's Hugo Chavez is a staunch supporter of the Ayatollah, and is the world's fifth largest oil exporter. "The US imperialists invaded Iraq looking for oil and now they are threatening Iran for oil, not because the Iranians are developing some kind of nuclear bomb," Chavez said on March 21st. Chavez could become a wildcard in the oil market in the event of a US strike against Iran's nukes.

Pension funds poured money into crude oil, base and precious metals in March, putting the "Commodity Super Cycle" back on track after a period of consolidation in February. Copper, which has gained 98% over the last two years, has zoomed nearly 32% higher so far this year. Zinc has doubled from a year ago. Crude oil has gained only 10% since the start of the year, but is up 93% from two years ago.

Copper supplies at the London Metals Exchange stand at 111,800 tons, or less than three days of global consumption. Zinc stockpiles have plunged 53% in the past year to 267,650 tons, equal to less than 10 days of global consumption. US crude oil supplies are at a 7-year high, but only represent 20 days of imports. US oil companies appear to be stockpiling oil for an uncertain future.

There are about 10,000 hedge funds managing up to $1.5 trillion in assets around the world, and institutional investment in commodity index funds has topped $80 billion. Former Fed chief "Easy" Al Greenspan, was quoted in January, saying gold's rally did not reflect heightened inflation expectations, but rather geo-political tensions around the world. With the yellow metal bumping up against the psychological $600 per ounce level, its highest in 25-years, perhaps Gold knows what no one knows!

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Gary Dorsch

Author: Gary Dorsch

Gary Dorsch

Gary Dorsch

Mr Dorsch worked on the trading floor of the Chicago Mercantile Exchange for nine years as the chief Financial Futures Analyst for three clearing firms, Oppenheimer Rouse Futures Inc, GH Miller and Company, and a commodity fund at the LNS Financial Group.

As a transactional broker for Charles Schwab's Global Investment Services department, Mr Dorsch handled thousands of customer trades in 45 stock exchanges around the world, including Australia, Canada, Japan, Hong Kong, the Euro zone, London, Toronto, South Africa, Mexico, and New Zealand, and Canadian oil trusts, ADR's and Exchange Traded Funds.

He wrote a weekly newsletter from 2000 thru September 2005 called, "Foreign Currency Trends" for Charles Schwab's Global Investment department, featuring inter-market technical analysis, to understand the dynamic inter-relationships between the foreign exchange, global bond and stock markets, and key industrial commodities.

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