Monday, December 18, 2006

Getting Ready for Round II

EUR/USD 1.3084 Hi 1.3121 Low 1.3051
USD/JPY 118.09 Hi 118.30 Low 117.68
AUD/USD 0.7800 Hi 0.7841 Low 0.7781
EUR/JPY 154.56 Hi 154.71 Low 154.09

If the USD bulls aren't worried they should be. It looks like the little burst of USD short covering, helped along of course by our kindly Central Banker friends, has come to an end. So it's time to get ready for the USD sell-off MARK II.

Friday everything was looking pretty good. CPI numbers released in the States came out way under market expectations with NO RISE at all in either CORE or HEADLINE CPI Inflation in November. Good news. And the U.S. American Consumer, the last bit of the U.S. economy which still functions, is still out there spending money. Recently released Retail Trade numbers were way higher than anyone forecast in November. So great news all round. Mr. Joe Average is still spending, even though he has no money, lots of debt, his real estate is falling in value and some ominous economic clouds are looming on the horizon. And the impact of this CONSUMER SPENDING on CPI INFLATION has so far been muted, so no need for the FED to get all nasty and hike. The GOLDILOCKS economy is BACK!! Only not really.

The FED isn't really concerned about inflation, that's just a front. The problem is the dollar or more precisely the capital inflows which the U.S. needs to attract every single day of the year for ever and ever till the end of time. Or until the U.S. actually learns to spend LESS than it earns.

Then we had some MORE GOOD NEWS. Capital Inflow numbers for October released last week were better than expected. The U.S. actually managed to attract all the money it needed to keep its head above water in October. So nothing to worry about. Foreign Investors just don't know what else to do with their dough so they keep ploughing it in to U.S. financial markets. But of course what else could these people possibly do with their money? Best not go there.

This explains why after the brief burst of short covering on Friday, following the VERY POSITIVE CPI NUMBERS, U.S. Treasuries actually managed to close DOWN on the day and a A LOT DOWN on the week. And Treasuries are DOWN again today. Ooops.

We all know that the U.S. Treasury market depends on Foreign Capital Inflows. It used to be a dependency AT THE MARGIN. A crucial dependency but just one of those things you needed to monitor from the corner of your eye. Now, with something approaching 50% of U.S. Treasuries in the hands of Foreign Investors, it's no longer a marginal phenomenon: it's centre stage.

The Bush Administration knows this which is why the Bush Administration has followed such a prudent fiscal policy platform. Bush and his buddies are working to make America more free and independent. Bush knows that Foreign Investor Confidence in USD denominated assets is crucial. Bush knows that the U.S. can't afford to scare off Foreign Investors and that the parlous U.S. financial situation needs fixing. This explains why the Pentagon is being so prudent in its SPENDING operations. It also explains why the Bush Administration is reluctant to up the ante in Iraq, despite SAUDI pressure to stay. Bush knows that the U.S. can't afford to continue the expensive war in Iraq. Only, unfortunately along with a few well-documented problems with language, President Bush seems to have a MATHS DEFICIT.

While initially it seemed that Bush did intend to read the recent Baker Report on Iraq (the one which called for a radical new plan and a PHASED WITHDRAWAL) now it seems that Bush was merely playing lip service to the nice men and women who drew up the report. This is a bit like playing lip service to Compassionate Conservatism while you let New Orleans rot. It's kind of a hall mark of the Bush Administration. You say what you need to say to deflect criticism and disarm your opponents and then you do whatever you decide you want to do, regardless of what has been said. This has the advantage of confusing everyone and giving you extra time to execute your agenda and by the time anyone wakes up to what is happening it's too late: it's done.

So, it appears, Bush has decided that his original plan is the right one. The only real problem has been the execution. And the problem with the execution has been that not enough money has been thrown at the problem. So the delayed Bush Agenda for Iraq now appears likely to be an agenda which will require more troops and more MONEY. Money which those nice Foreign Investors, who so whole heartedly supported the Iraqi Invasion from the get go, are sure to provide.

Of course it's at this specific juncture that Henry Paulson has decided to go to China to try and convince the Chinese to buy considerably LESS USDs. Which kind of settles the argument about whether the people from Goldman Sachs are really smart or just overpaid. The Paulson Bernanke team were out in China trying to convince the Chinese that if they just let their currency appreciate (BY BUYING LESS USDs) then the Trade Imbalance between the U.S. and China will fall. They know this because this is what happened with the U.S. Japan Trade Imbalance. The YEN has doubled in value following the Plaza Accord and the U.S. now has a very large Trade Deficit with Japan. Just like before. Jeez.

And guess what? Today the people who tell us about such things informed everyone that the U.S. External Funding Requirement (aka the Current Account Deficit) hit a record in the Third Quarter. In order to keep the USD stable the U.S. NOW needs to attract around USD 225.6 billion IN NEW MONEY per quarter. The next wave of the USD sell-off is about to start. Mr. Joe Average may still be on a spending spree and this may even see U.S. GDP numbers improve but it's not going to do anything but INCREASE the U.S. External Funding Requirement. And right now Foreign Investors are increasingly concerned about where all this is heading. Bad news for the USD.

OIL 62.51
GOLD 616.70

The OIL market has suddenly discovered the mild weather that we've been having for the past two months. On the ball!! And this is the reason that the OIL price is a little softer. It's not that economic slow down on the horizon for the U.S. next year. No, financial markets, particularly at YEAR END only do GOOD NEWS. So mild weather and the very stable situation in the Middle East is putting downward pressure on OIL.

GOLD keeps sinking. Indeed, Commodity Markets as a whole don't look too bubbly right now. The possibility of a U.S. recession in 2007 which would leak into Asia, via China and Japan, has a way of cooling demand for all sorts of stuff. Commodities being right up there at the top of the list. Pretty soon we will find out which really big Hedge Funds are holding really big Commodity Market bets. 2006 has been fun. 2007 should be a doozy.

In order for GOLD to perk up significantly, given the less than stellar outlook for the global economy, we would need to see the USD really take a big hit. Despite the dramatic headlines and the conspiracy theory blogs which litter the internet predicting that the USD will soon be worth ZERO, the USD decline has so far been orderly. All we are seeing is the air being let slowly out of the USD balloon. For GOLD to really start performing we would need a few pins used on the USD balloon. At present pretty much everyone has a vested interest in NOT seeing that happen. Doesn't mean it won't but everyone from the shady PPT to the secretive Central Bankers of the world will be working to stop the trickle of USD selling which we are seeing become a flood. Still, only those with a healthy appetite for risk should be sitting on bucket loads of USDs right now. Because all the longer term USD risks are negative.

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