Moneyization Part Thirty-two

By: Ned W. Schmidt | Mon, Nov 13, 2006
Print Email

Moneyization: The global financial phenomenon of individuals and businesses moving their funds to monies in which they have the highest confidence, or money in which they have a higher store of faith.

Or, Gold May Benefit From Election

The Congressional election in the United States of last week has some immediate ramifications that should not be ignored by investors, especially those in North America. Foremost, the results have serious negative consequences for the economic and global power of the United States. To some childlike minds that may be good, but the weakening of the global hegemon has never had positive results. Those interested may want to see Kindleberger on the causes of the Great Depression. Another hint that the People's Bank of China will diversify their foreign exchange reserves may be, one, a partial consequence of that degradation of power, and, two, encouraged by isolationist nature of the new Congressional leadership. Quite simply, one does not buy the stock of a company with weakened leadership and eroding market power.

Second and of most concern, Nancy Pelosi is now two 'heartbeats' away from being President of the United States. The President and Vice President of the United States now become important and primary targets of the radical Islamic clerics. The release of an audio tape on Friday of Abu Hamza al-Muhajir, the leader of Al Qaeda in Iraq, may not have been a chance event. In that tape al-Muhajir said, "We will not rest from our Jihad until we are under the olive trees of Rumeih and we have destroyed the dirty black house - which is called the White House"(,10 Nov 2006).

This statement may be no idle threat. Under the Constitution of the United States, the Speaker of the House, which will be Nancy Pelosi in January, is third in line of succession. In no time in the history of the U.S. has the elimination of the President and Vice President carried such reward to forces like Al Qaeda. This group has openly praised the election results. A set of targets with rewards for the Islamic terrorists is readily evident. Was this audio tape a signal to operatives to begin implementing a planned attempt?

Remember too, their interpretation of the election is that the body politic of the U.S. has rejected military action in defense of the U.S. or its interests. Gold is insurance against the violent politics of the world. Some in the world may see a violent transition from Bush/Cheney as good, but reality is for different. While certainly not predicting what Al Qaeda may do or not do, owning Gold in such a world is certainly a good precaution. Remember, terrorism is not a reason to buy Gold. Terrorism is a reason to own Gold.

Moneyization is the movement of wealth to those national monies in which investors have a higher faith. For the past decade central banks accumulated a vast outpouring of U.S. dollars due to the Greenspan induced consumption binge in the United States. With a mounting pile of dollar denominated assets, central banks around the world have been for sometime diversifying into debt denominated in other national monies. The People's Bank of China, with more than a trillion dollars of foreign exchange reserve, is a "big hammer" in the global financial markets. Diversification of their foreign exchange reserves to investments not denominated in U.S. dollars has serious and negative ramifications for any investor foolish enough to be invested predominantly in assets denominated in dollars.

The details of the intentions of the People's Bank of China are not known, but the direction has been made clear. "'We have had a very clear diversification plan for several years,' he[Zhou Xiaochuan, governor of the People's Bank of China] said on the sidelines of a European Central Bank conference in Frankfurt"(Financial Times,10 June 2006,42) to Reuters. This further reminder that the People's Bank of China will diversify its holdings of foreign exchange reserves should not be ignored by investors.

One foolish paper asset groupie was quoted as saying that this meant they would buy U.S. corporate debt and mortgage backed securities. To this near financial twit, such a move would be diversification. In reality, such purchases would not be diversification. Adding more dollar denominated assets to the already gigantic holdings of such investments by the People's Bank of China is not diversification. Diversification would be the movement of funds to assets not denominated in U.S. dollars. The information in the following table can help investors understand the possible direction of future investments of China.

IMF, MAY 2006
WORLD U.S. China
% Paper 90% 28% 99%
% Gold 10% 72% 1%
Gold Million Ounces 876 262 19
Paper Investment$Billions $4,616 $57 $1,044

The above table summarizes the approximate investment in paper assets and Gold by the central banks of the world. This data was derived from the monthly International Financial Statistics (August,2006) published by the International Monetary Fund. Naturally these values are estimates, but are about the only reasonable numbers available.

A central bank, like the Bank of Canada or People's Bank of China, accumulates foreign exchange reserves when the nation runs a trade surplus. Those inflows of money are invested generally speaking in either investment grade government debt or Gold. For some time, much of that money has been invested in debt issued by the U.S. government and agencies. Currently about $1.1 trillion of U.S. government debt and about $551 billion of bonds issued by U.S. government agencies are owned by foreign central banks. The size of these holdings is included in the weekly release of the Federal Reserve, where these investments are held for the central banks.

Any move by China to diversify foreign exchange reserves is reasonable and to be expected given the inappropriately high investment in paper assets. As the table shows, approximately 99% of China's $1+ trillion foreign exchange reserves are held in paper assets, largely U.S. dollar denominated debt. Any rational and logical diversification move would be away from paper assets, principally U.S. dollar debt. The under owned asset in China's portfolio is Gold.

Central banks of world have purchased U.S. dollar debt for two reasons. First, dollars are what they have been receiving from U.S. consumers in the purchase of goods. Second and most important, U.S. debt is the largest and most liquid debt market. No other nation has $8+ trillion of debt outstanding that trades on a regular basis. The next step would logically be Gold purchases. Based on the statistics in the above table, China would need to purchase more than one hundred million ounces of Gold simply to be in the same position as the average central bank of the world.

Those running the People's Bank of China are aware of the implications of their current investment portfolio. They have been to the schools. Some have advanced degrees. We are not talking about the financially naive. They surely recognize that their dollar denominated assets have been a bad investment for some time. As the chart above portrays, the value of the dollar is near a cycle low. As the value of the dollar has fallen so has the value of their dollar denominated investments. Gold has and will likely continue to perform better than their paper investments.

Also shown in that graph is that when the value of the U.S. dollar declines the dollar price of Gold rises. A new low for the median dollar value is likely, and that should push up the dollar value of Gold sharply. $Gold is in process of positioning for a significant move higher. The results of the U.S. Congressional election are part of the fuel for the next significant move in $Gold.

Dollar denominated investments have performed poorly for some time due to the depreciation of the U.S. dollar. The managers of the PBC realize that these dollar denominated assets have been losing value in real terms, and will likely to continue to lose value. Readily apparent in the above chart is that the U.S. dollar is not much above its low for the last two years. Given the continued outpouring of U.S. dollars, about $60+ billion a month, and the already bloated holdings of dollar assets by central banks, the value of the U.S. dollar has only one path of least resistance, down.

The above chart is of central bank holdings of U.S. debt, which are held at the Federal Reserve. The solid line is the total of those holdings, and uses the left axis. That total is approaching US$1.7 trillion. More important are the bars which portray the year-to-year change in those holdings , using the right-hand axis. While the size of the total holdings has continued to rise, the rate of increase has clearly slowed. In late 2004 central banks were accumulating U.S. debt at a $325 billion annual rate. More recently the rate of accumulation has been at around a $225 billion annual rate.

As central bank holdings have become bloated with U.S. debt, they have been reducing the rate of purchase of additional U.S. debt. Given that the U.S. trade deficit continues to be at about a $700+ billion annual rate, central banks must be diversifying their holdings into non-dollar debt. That lower rate of accumulation has caused the value of the U.S. dollar to fall by 7% on the median-based measure in the earlier graph. $Gold rose from about $400 to more than $600. The potential fall in the value of the dollar and price appreciation potential for Gold is considerable if these trends continue.

This clearly negative situation will be exacerbated by an economic recession induced by a housing market collapse that is now rapidly approaching in the U.S. The major reason that interest rates have remained so low in the U.S. is due to foreign central banks purchasing U.S. debt at over a $200 billion annual rate. As these purchase slow and then turn into liquidation, interest rates in the U.S. will rise and the housing market collapse will be accelerated. That will cause a further collapse in conditions in the U.S. housing market.

The national media has not really reported the developing situation adequately. Perhaps talking about GOOG and other such nonsensical speculations is more fun. According to RealtyTrac and reported by on 10 November 2006, foreclosures on home mortgages in the third quarter were 318,355 nationwide in the U.S., up 17% from the second quarter. Leader of the pack was Detroit where one out of 80 homes was in foreclosure, up 42% from second quarter. #2 was Broward County Florida(Ft. Lauderdale) with one in 88 in foreclosure, an 87% increase. In Denver, Colorado one of 90 was in foreclosure which is a 30% increase.

Wall Street economists live in a fantasy world that believes the Federal Reserve will cut interest rates in the early part of 2007, and therefore engineer a miraculous saving of the U.S. economy which will then glide into a soft landing. Did you ever see a brick have a soft landing? That rate reduction will not make the problems go away. Detroit is in housing collapse due to a combination of auto industry job losses and mortgage excesses. An interest rate reduction will not recreate those lost auto industry jobs. The situations in Ft. Lauderdale and Denver are related largely to speculative buying and inadequate underwriting standards for mortgages which will not be reversed by some interest rate reduction. When a boulder starts rolling down hill, it will not stop rolling till it hits bottom. Such is the way economic gravity works, regardless of any pixie dust spread by Wall Street gurus.

As the U.S. recession spreads and the credit problems become more apparent, the U.S. dollar will come under further selling pressure. Uncertainty over the credit worthiness of this debt will increase, causing foreign investors to sell dollar assets. The end of the dollar's problems has not arrived, not even the beginning of the end. Along with these fundamental problems for the U.S. dollar, any attempt to lower interest rates will make U.S. debt less desirable in a world where other interest rates are rising. The European Central Bank and the Bank of England have already indicated that rates are likely to be increased. Economists in the investment world live in a fairy tale where in their thinking the rest of the world does not exist. They and the other dollar bag holders will find out different.

A defense does exit against this dollar problem, and it is Gold. Now that the Gold market has moved beyond the false rally caused by hedge fund trading, real opportunities for investors are again being created. The above chart, part of the regular charts in The Value View Gold Report, portrays how the hedge fund impact was unwound during June, creating a timely chance to buy. Another was recently created in October. Given that $Gold is in the process of creating a new formation separate and distinct from that false pattern built on hedge fund buying, investors would be well advised to prepare for participating in the unfolding Gold super cycle that should carry to US$1400. Use all price corrections when they come for buying.

Corrections are a natural part of any markets, and corrections are likely in $Gold. These corrections should be used for buying Gold. The longer term fundamentals are too strong to ignore. Many are still worried, and they must overcome that unnecessary worry. Part of the positive feelings on Gold come from the continuing improvement in Silver, shown in the chart above. Silver just continues to build a nice chart picture. That unfolding improvement is due to the fundamental buying by investors. Investors aware of the future, and not being misled by CNBC's paper asset groupies, continue to demonstrate real demand for Silver.

Silver was battered after the last hedge fund explosion. Since then, a pattern demonstrating market rebuilding and resurgence has developed. With Silver moving above $13, a test of the cycle high is likely. Again though, remember that all markets are at the present time somewhat over bought. These conditions often lead to corrections which should be used to buy or add to positions.

The GDM is portrayed in the above graph. This index can be found on The GDX, an ETF of Gold stocks, uses this index. GDX also can be found on the Amex. Several distinct buying opportunities have been created in the stocks. With the metals and GDM over bought, the possibility of a correction exists. These retracements, as shown in the chart, have been good times to buy. A correction is likely, and would set up conditions for the next advance. That move should carry through the 1150 level on the GDM, and set the stage for a new cycle high in this measure of Gold stock prices.

Markets never go straight up. Many thought the false rally on the hedge fund money would ever continue when $Gold moved above $700. Such optimism was unfounded, and doomed to disappointment. Now that the hedge funds are playing in the DJIA sandbox we can expect that market to soon take the "cure." Investors would be better served by accumulating cash from paper asset sales and preparing themselves for those times best suited for adding to positions in Gold, Silver, and the Gold stocks.



Author: Ned W. Schmidt

Ned W. Schmidt,CFA,CEBS
The Value View Gold Report

Ned W. Schmidt,CFA,CEBS is publisher of THE VALUE VIEW GOLD REPORT and author of "$1,265 GOLD", published in 2003. A weekly message, TRADING THOUGHTS, is also available to electronic subscribers. You can obtain a copy of the last issue of THE VALUE VIEW GOLD REPORT at The Value View Gold Report. Ned welcomes your comments and questions, and tries to answer most all. His mission in life is to rescue investors from the abyss of financial assets and the coming collapse of the U.S. dollar. He can be contacted at

Copyright © 2003-2016 Ned W. Schmidt

All Images, XHTML Renderings, and Source Code Copyright ©