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Gold and Energy Advisor's Real Wealth

Real Wealth #279  10/13/2010

Gold Soars to $1373 an ounce: Currency War Looming

Dear Subscribers,

One of my favorite institutional economic and market letters is The HCM Market Letter which sells for $395 a year and which I recommend to all serious investors (561-226-6199). The HCM Market Letter is edited by Michael E. Lewitt who is genuinely an independent thinker who consistently raises important issues that investors should be aware of but are all too often are completely uninformed about until it is too late.

His October issue entitled “Begger Thy Neighbor, Begger Thyself” points out the folly and consequences of both the massive stimulus spending and Federal Reserves next round of quantitative easing. In short, he expects an economic crisis to come from these errant policies between 2011 and 2015 and that it will make the 2008 Financial Crisis to look like a “tea party”. (Pun intended).

He writes that “Current policy measures guarantee future volatility and below-trend growth globally as U.S. European and Japanese central banks engage in a race to the bottom to debase their currencies and corrupt their balance sheets”.

While not taking a position on which political party here in the United States would best meet the economic challenges we’re living through he warns that “gridlock” is surely not the answer...

“We cannot afford two years of paralysis. The fact that we are seeing currency wars and political paralysis speaks to the severity of our ongoing crisis and the need for new leadership.

 The Race to the Bottom

Currency wars are an ugly spectacle to watch. While certain short-term benefits can be gained by such actions – cheapening a country’s exports and therefore giving a quick boost to its economy – every devaluation ends in tears.

The world is now being treated to the spectacle of three of its largest currency blocks competing to reduce the value of their currencies. Even more striking is the fact that the central banks in charge of these suicidal operations are being forced to engage in non-conventional means to accomplish their goals because conventional mechanisms of monetary policy have broken down.

*        The U.S. Federal Reserve is talking about engaging in a second round of quantitative easing. The media and others have termed this approach “QE2”, a name that sounds like a cruise ship. That is probably appropriate since such an approach is likely to meet the same fate as the Titanic.

*        The European Central Bank (ECB) was forced to bail out the peripheral members of the European Union with a €1 trillion rescue package that also included aspects of quantitative easing. In fact, European central banks recently purchased Irish government obligations after Irish interest rates rose to the highest levels since 2003.

*        Japan has seen the Yen rise to levels that are crushing its exports and has engaged in direct intervention in the currency markets. On October 5, the Bank of Japan pledged to keep its benchmark interest rate at “virtually zero” until deflation has ended and cut the overnight call rate target to a range of 0 to 0.1 percent from 0.1 percent, a gesture whose microscopic size speaks to the lack of options available to a central bank incapable of thinking outside the box.

I take no pleasure in saying with a high degree of certainty that none of these efforts are going to yield the desired result. Currency interventions never work in the long term and rarely produce more than a fleeting short-term boost to an economy. The only way to manage currencies effectively is to manage the economies that employ them effectively. Currency imbalances are signs of underlying economic imbalances, and the current currency chaos is nothing more than a reflection of failed economic policies in the United States, Europe and Japan.

It would be far more effective for each of these countries’ central banks and governments to promote pro-growth, equity rather than debt-financed tax and economic policies rather than the current unsustainable debt-financed growth that has led them to their current precarious positions.

Currency problems are just a symptom of underlying economic diseases, and these countries need to treat the diseases and not the symptoms if they want their economies to heal. There is little indication, however, that they are prepared to do so. The reasons for this failure are both political and intellectual.

Unless the laws of economics have been repealed, there can only be one outcome from the actions of the Federal Reserve and the ECB – weaker currencies and higher inflation.”*

Fears of a Currency War ....

Why gold should be added to your portfolio.

I’ve been warning about the risk of a currency and monetary crisis since the writing my book “The New Bull Market in Gold: $1,000 Gold and the Many Ways to Profit from it.

In recent days there have been dozens of stories in the financial press concerning the risk of a “Currency War”.  Here are just a few headlines...

*        Fed Undaunted by Uncertain Prospects for Money Printing

*        Euro briefly above $1.40 amid currency war fears

*        Dollar Steadies Amid Currency War

*        Countries that are Using the Currency War to Increase their Tax Base

*        Impossible to solve: the currency wars

*        China and US on Currency War

Soros Sees A Global Currency War on The Horizon.

This most recent headline concerning George Soros is one I recommend taking special notice of – after all came to fame by betting against the Bank of England and the sterling in 1992, and subsequently made over $1 billion from the trade.

George Soros while loading up on gold makes no bones about the fact he sees a currency war happening, and if the result is China versus the rest of the world, it could seriously threaten the world economy as we know it. Keep in mind I’ve been writing about the danger China posses for several years. Now with over $2.5 Trillion in U.S. currency the danger is finally starting to catch the attention of billionaire speculators and investors.

Soros criticized China for its low Yuan policy, and said that China has created an enormous advantage for itself, as it controls the value of its currency, whereas other foreign competitors do not.

In the Financial Times, Mr Soros wrote, "Whether it realizes it or not, China has emerged as a leader of the world. If it fails to live up to the responsibilities of leadership, the global currency system is liable to break down and take the global economy with it."

The point missed by most is China is becoming so strong economically that it not only can control the value of its currency but by doing so also manipulate the value of the U.S. Dollar, Yen, Euro and Pound. In short while engaged in every effort to become - the world’s dominate military superpower, it’s been taking steps to become the world’s dominant economic power. Those immense gold purchases and China’s race to buy copper, nickel, oil and other key commodity producing properties around the world is just another bold hint of their strategy.

While it’s true that a currency war and resulting panic and crisis would crush the real buying power of Chinese foreign currency and foreign investments, it’s also true that such a panic and crisis, would only serve to solidify China’s superpower status.

Finally, I want to point out that in this month’s HCM Market Letter Michael E. Lewitt points to a potential ETF crisis. He has the distinction of being the first to serious point to ETF’s as the potential for trouble...

ETFs – The Next Time Bomb?

  “Think about this: A new financial product is created whose value is based on the value of an underlying portfolio of other securities; this product becomes so popular that it comes to outgrow the volume of underlying reference securities in size and trading volume; and regulators do nothing to limit the growth of this product or consider the systemic ramifications of its growth.

Sound familiar? No, we are not speaking about credit default swaps, although this description fits what occurred with those weapons of mass financial destruction that brought the financial system to its knees in 2008. We are speaking about ETFs, which have exploded in popularity and come to dominate (along with flash trading and algorithmic trading) the equity markets.  A plain vanilla ETF, for our lay readers, is a security that represents ownership in an underlying basket of stocks, bonds or commodities that are held in a segregated account for the benefit of the ETF holders. In addition to plain vanilla ETFs, there is a plethora of leveraged ETFs that provide holders with leveraged plays on specific sectors or asset classes. Plain vanilla ETFs, like credit default swaps, are useful products if properly utilized and regulated. Leveraged ETFs, as our friend Eric Oberg has exposed on, are quite another story. But the problem with the collective ETF universe is that, like anything else on Wall Street, enough is never enough. There may now be as many ETFs as stocks, and it is impossible for there to be enough stocks to fill all of these ETFs. The problem is compounded as more exotic or sector specific ETFs are brought to market, such as country-specific ETFs in emerging markets where the underlying stock markets and individual stocks are far less liquid than the U.S. stock market.

This raises the question of what happens when all of the ETFs holding a specific stock decide to buy or sell at the same time. In the CDS market, we saw how the spawning of billions of dollars of these products tied to a single underlying bond obligation created the illusion of liquidity in the bond market and moved bond spreads tighter than justified by underlying credit fundamentals. Before credit crashed beginning in 2007, spreads on high yield bonds reached a ridiculously low level in the low 200s, which offered investors woefully inadequate compensation for the risks they were assuming in lending to highly leveraged companies. We also saw how speculators could drive the borrowing costs of individual companies to levels that rendered these companies unfinanceable and essentially insolvent (i.e. Bear Stearns, Lehman Brothers, and almost BP plc).

The dynamics of ETFs are different, but there is no way that the continued proliferation of ETFs can be a stabilizing force in the markets. First, the differential between liquidity at the ETF level and liquidity at the level of the underlying stocks owned by the ETF is a recipe for trouble. Second, the enormous amounts of capital that ETFs are attracting make it more difficult for companies to attract capital directly in the stock market. Just as CDS drew capital away from the corporate bond market and rendered it less liquid than it would otherwise be, ETFs are drawing capital away from individual stocks and making them less liquid. Coupled with flash and algorithmic trading, ETFs have completely changed the complexion of equity trading, and not for the better. Even the stocks with the largest capitalizations such as Exxon trade mostly in 100 share increments as a result of the ascendancy of the computers, negatively affecting liquidity.

What is most shocking about the untrammeled growth of ETFs is that the regulators are once again asleep at the switch. The world has seen this movie before and it ended badly. Credit default swaps were allowed to grow into a multi-trillion dollar market without any oversight.

Now ETFs are being allowed to do the same without any consideration of their systemic effects. While prospectuses must be filed with the Securities and Exchange Commission, regulators are looking at the trees instead of the forest. It is irrational and irresponsible to permit an unlimited number of ETFs to form when each of them has to purchase individual stocks. The implications for market volatility and capital formation are immense. We are witnessing another enormous policy and regulatory failure unfolding before our eyes.”*

Michael E. Lewitt’s concerns about ETF’s mirror mine. But I also remain increasingly concerned about the both the tremendous amount of leverage in both the Forex and Comex precious metals contracts.

God forbid we wake up one morning and gold has jump $250, $500 or even $1,000 an ounce as the result of another unforeseen exogenous event.

The paper meltdown that would take place would for ever change the world’s financial markets. The exchanges would surely have be shut down (perhaps for several days) until all the losing positions (which could amount to hundreds of billions of dollars, perhaps approaching a trillion) were dealt with. The damage would not only be seen in the commodity and currency markets but also in the world’s equity markets.

It is little wonder that Michael E. Lewitt has been recommending and still recommends gold as investment. As he points out he’s been recommending gold for several years and is still recommending it even though many other have jumped on the bandwagon.

Best Wishes,

James DiGeorgia,


P.S. Gold continues to rise – trading at a new all time high today $1,373 an ounce. As I pointed out to a reporter yesterday, Gold isn’t a bubble it is in the process of climbing to $2,000 or more in order to reach equilibrium. In terms of 1980 dollars gold should be trading between $2,000 and $2,500 just to keep up with the steady decline in the value of the U.S. Dollar.

Last week we purchased a nice group of 24k Gold NGC graded and certified Mint State 70 (MS70) 1 ounce Buffalo gold coins and with in a few hours we were sold out.

I’ve purchased another small group of these very same coins. Each coin is literally flawless coins that trade at a modest premium over the spot price of gold. They’re beautiful magnificent coins that are very much in demand. When you buy two or more of these coins we’ll extend your subscription to the Gold and Energy Advisor for 1 year – a $79 bonus. Purchase 10 coins or more and we’ll give you a 5 year subscription extension. Call 1-866-697-4653 highlighting and speak to one of my gold representatives at Finest Known, LLC. With the price of gold climbing so fast it is literally impossible to set a fixed price. However, I have instructed my gold representatives to work as closely as possible so as to insure you get a great price on these amazing gold coins.

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