FYI | Nov 02 2006
By Greg Peel
The fact that so many commentators have been calling a slowdown in the US economy, and a subsequent fall in the US dollar, it is in itself surprising that poor economic data is still being met with surprise. Such was the case on Wall Street overnight.
To be fair, debate has raged as to whether such a slowdown would prove simply a healthy “soft landing”, or whether the R-word should be dusted off. As Wall Street has been enjoying a season of strong reporting, investors have been quick to ac-centuate the positive and eliminate the negative, sending the Dow to record highs. At least one chief investor officer believes investors are in an Egyptian river.
It could be argued that as US companies are reporting quarterly results that have yet to feel the impact of a slowing economy on the bottom line. Or it can be argued that under a platform company-based model US companies can still enjoy healthy profit margins in good times and bad. Either way the Institute for Supply Management (ISM) announced that manufacturing growth in October was at its lowest level in three years.
Add to this yet another poor US housing statistic (there seems to be a plethora of different measures), and the Dow turned heel and ran. “Pending house sales” fell 1.1% in September to be 13.6% down from last September and residential construction spending also fell 1.1% making it six straight monthly falls.
The Dow finished down 48 points at 12,031, having been lower earlier. This 0.4% fall was pipped by the S&P500 (-0.7%) and Nasdaq (-1.4%).
Profit-taking on Wall Street at present is to be expected anyway ahead of the mid-term congressional elections. As the US focuses on 100 dead Americans in October (never mind thousands of Iraqis) the odds increase for the Democrats to win back control in the house. This is traditionally negative for big business, which likes to hitch its wagon to God, the dollar, and the Republicans.
One-time presidential hopeful and Democrat campaigner, John Kerry, suffered from foot-in-mouth last night by telling college students that if they didn’t study hard they could end up in Iraq. While the Republicans seized on this supposed gaffe, many Americans were probably quietly agreeing.
More interesting overnight was the pick-up in the gold rally.
Gold has fallen in recent months due to a combination of lower oil prices and central bank sales. Gold typically has a tenuous correlation to the oil price, based more on the indirect effect of global tensions affecting oil, and thus general security concerns. Hence the oil price-correlated fall could be attributed more to Iran being more willing to negotiate over nuclear energy than the specific fall in crude.
North Korea has been another bone of contention, but the ravings of Kim Jong-il did not materially affect the gold price last month, and so it has neither been affected by the news (as long ago suggested by FN Arena) that NK is prepared to reopen nuclear discussions.
So last night the focus was solely on the weakening US dollar, as buying demand out of Asia helped to drive spot gold up US$11.70 to US$617.70/oz.
A forecast softer dollar has been the mainstay of gold bulls for some time, despite the metal’s apparent reluctance to rally before now. This doesn’t necessarily mean the floodgates are open, but bulls have taken comfort once more that gold is responding as it should – as an alternative reserve currency – and is not focused on suggestions this week that supply would outweigh demand in 2007 (See “Fortis Bank Forecasts Weaker Gold Demand”, 31/10/06).
Fortis Bank qualified its findings by suggesting the dollar may be the difference that could still lead to a gold price rally, and surprisingly the report suggested zero central bank purchases in 2007 when talk out of Asia and Russia, at least, has been of potential increases in gold reserves.
Already the UAE – the second largest Arab economy – has announced it will reduce its US dollar reserves by 50-90%, and it is yet to make good on its pledge to convert 105 into euros and gold.
Fortis also focused on less producer de-hedging in 2007, and less ETF demand.
On the former, AngloGold Ashanti (South Africa’s biggest miner) announced yesterday it had reduced its hedge book commitments from US$3.17bn to US$2.78bn by no longer forward selling gold, and by delivering into existing contracts.
On the latter, US gold fund manager John Hathaway has had this to say in a recent essay:
"Should fear revisit the financial markets, buying power for gold is without precedent. While the gold mining industry struggles to produce 2,500 tonnes per year, an amount that would increase the above-ground stock of gold by a paltry 1.7 percent, the financial system continually spews out a blizzard of new financial assets, all of which represent potential claims for liquidity and safety.
"In the bleak days of 1935, the market cap of above-ground gold equaled 15 percent of U.S. financial assets. In 1980, when bonds were dubbed ‘certificates of confiscation’ and good-quality equities traded at six times earnings and 6 percent dividend yields, that same percentage was 29 percent. In today’s carefree world, that percentage is only 3 percent. The price of gold can double or triple in the absence of catastrophic outcomes simply as more investors attempt to position the exchange-traded fund.
“That is, the ratio between gold and all other financial assets is more extreme than ever, and as Wits Gold Chairman Adam Fleming said at GATA’s Gold Rush 21 conference last year, even a small move by investors can take the central banks out of their gold.”
Hathaway’s comments speak to the belief that central bank gold holdings are no longer sufficient to prevent a flood of buying from investors, no matter how much the US Treasury may wish to support the US dollar.
The mood is still bullish. While gold analysts GFMS have slightly tempered their view (they now see gold at US$640/oz by the end of the year and at US$700/oz in early 2007) the latest fears of supply overhang seem not to have had a material effect.