Monday, January 15, 2007

Iraq, Iran, Oil, Gold and Bizarre Tilting Points

EUR/USD 1.2940 Hi 1.2960 Low 1.2914
USD/JPY 120.40 Hi 120.62 Low 120.06
AUD/USD 0.7842 Hi 0.7863 Low 0.7835
EUR/JPY 155.83 Hi 156.11 Low 155.07

Well Trichet took a giant step back last week. No more rate hikes are to be expected in Europe till after the French Presidential Election. Stocks cheered and the EURO rallied. But the FX market has no conviction. The market is confused and looking for direction. The pundits are telling us that the U.S. economy is RESILIANT, that the Japanese economy is in recovery and that the strongest European economy is Germany with France now falling behind. Only the last two statements appear to be true.

The way things are going the U.S.A. could see the yield curve flatten out altogether and then even turn positive. But that doesn't mean that the economy has turned the corner. All it means is that the Bush Administration is having trouble finding investors reckless enough to fund George W.'s bizarre Imperial Game Plan. The U.S. Consumer may well have whipped out the credit cards over the Christmas Holidays and the U.S. Consumer is 70% of the U.S. economy but economic growth is built on more than an ability and willingness to borrow and spend money. Any fool can spend money.

While every pundit out there is talking about the resiliency of the U.S Consumer and what great news that is, no-one is talking about where the money is coming from. Because that's the scary part. And the facile explanation that U.S. Treasuries are selling off because the economy and INFLATION may be stronger than previously forecast is simply rubbish. Currently 55% of the U.S. Treasury market is held by Foreign Central Banks. These Banks don't care where domestic U.S. inflation is heading. It's not like they shop at Wal Mart. The only INFLATION, in the sense of loss of purchasing power, that they care about is entirely currency related. A fall in the value of the USD and the value of their holdings falls. So the trick to keep Foreign Investors lining up at every Treasury Refunding is to keep the USD supported, despite a massive external funding requirements. This is not easy.

If the confidence of Foreign Investors is not maintained then the whole charade falls over.

So the USD is crucial. And confidence in the Bush Administration's commitment to a STRONG DOLLAR POLICY is crucial. Everything else is expendable. And that means the U.S. Consumer is expendable. So don't bank on a Consumer Driven economic recovery happening in the U.S. any time soon.

OIL 53.20
GOLD 627.90

Over the quiet trading days of year end and New Year the GOLD bears got to work. They didn't get all that far, but they did try. GOLD didn't break below USD 600 but GOLD bearishness hasn't disappeared entirely. What the world is waiting for now is to see how the Bush Administration's New Plan for the Middle East pans out. The expectation is that the SURGE in Iraq is just a distraction. The real escalation will happen when the U.S., or one of its allies, attacks Iran.

And the time table is becoming clearer. We are talking APRIL. China and Russia were persuaded just before Christmas to vote for sanctions against Iran at the United Nations. No-one knows what kind of horse trading went on to persuade China and Russia to drop their U.N. veto. But they did and now they are sidelined. The Saudis, for reasons to do with some obscure rivalry with "The Persians" aka Iran, are on board and so are the Israelis. After all they are the mostly heavily armed nation in the Middle East and hence believe that any military conflict will go their way. So we have clocks ticking.

Before April the French will be too involved with their Presidential election to make trouble. Tony Blair will still be in office, advocating the use of force and playing poodle to George W.'s cowboy. Oh and there is an off-chance that France will elect the Pro-American Sarkozy. So that's France out of the game. And if it's not Sarkozy it will be the ineffectual Royal. Both French Presidential candidates are great admirers of Tony Blair. Why? Well not for his achievements, obviously, but because he showed everyone how to use the media to gain and hold power. Photo opportunities anyone? What the world doesn't need is more of these kinds of politicians. So France really is out of the game.

Now I'm guessing that an American attack on Iran is going to be bad news for pretty much everybody. First, for the Iranians and then for the rest of us. But hey after you've slaughtered 650,000 Iraqi civilians where are the moral guidelines? The point is winning. Though, strangely in a Nation where "IS" needs to be defined, no-one has been asked to define "WINNING". Nor has anyone explained how you "WIN" an "ENDLESS WAR" on Terror. Doesn't endless mean there is no end point? Well exactly. Orwell had the blueprint but no-one reads books anymore so Cheney and his buddies have everything wrapped up.

Either way ugly GEOPOLITICS will help keep GOLD bid and, unless someone changes George W.'s medication, that seems unlikely to change. Or at least that's the conventional wisdom.

But there are other views out there. And if you take the view that war is profitable but unpredictable, unless relatively contained, then you could take the view that there will be no escalation, just lots of veiled threats. So we could, right now, be right on the brink of some bizarre equilibrium where there is no resolution and no escalation. Or at least an attempt by the powers-that-be to hold on to a bizarre equilibrium.

The trouble with that point of view is that a) it overestimates the intelligence of the people involved by a large margin and b) it underestimates the imponderables and the unpredictable. This is Karl Rove's November election strategy to the power of 100 and we all know that the Karl Rove strategy failed. These people may be devious but they are not really smart, they just think they are.

So we don't really know how things will fall but we do know that it would be unwise to take any serious bets on direction until the GEOPOLITICAL situation becomes clearer. There is a lot of deviousness around right now and not a whole lot of smarts. The U.S. Administration overestimates its own economic smarts. Ultimately that is bad news for the USD, U.S. Financial Markets and the U.S. economy. And bad news travels fast.

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