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Dollar Rallying Of Natural Causes


Don't blame currency manipulation.


In his August 13th Commentary Steve Saville gave his thoughts on the US Dollar, gold, and currency manipulation. Steve gave me permission to repeat that letter in entirety.

Before I post Steve's thoughts, I need to state upfront that they are similar to recent posts of mine that have stirred up quite a controversy. In case you missed them, here are my thoughts, in sequence:

One person accused me of "Yellow Journalism" over the first post, and numerous other people have written or commented that I have my eyes shut if I do not see manipulation.

Of course I see manipulation. Manipulation is all over the place. And I have commented on manipulations every week for months on end.

List of Manipulations

  • The alphabet soup of lending facilities (TAF, PDCF, TSLF).
  • The shotgun marriage between JPMorgan (JPM), and Bear Stearns.
  • Lowering the discount rate during options expiration week.
  • Lowering the Fed Fund's rate during options expiration week.
  • Treasury Secretary Hank Paulson jaw-boning about the "strong dollar policy" every few weeks.
  • Paulson stating that he would let financial institutions fail then three days later asking for unlimited funds to bail out Fannie Mae (FNM) and Freddie Mac (FRE).
  • Bernanke openly soliciting private equity to invest in banks.
  • Bernanke stating he would bend the rules to allow private equity to invest in banks.
  • The SEC changing the rules on naked shorting for shares of the broker dealers, Fannie Mae and Freddie Mac.

That is just a partial list of some of the most blatant examples of manipulation. However, other than a short term effect, not a single one of those accomplished a thing. And that is the point. Traders are now blaming currency manipulation for the recent huge rise in the US dollar. I don't buy it, and in case you want a second opinion here it is.

Steve Saville On The US Dollar Rally

A line of thinking within the "gold community" is that direct central bank intervention caused last week's US$ surge. Specifically, some gold-market analysts/observers have said that the catalyst for the rally was the purchase, by foreign central banks, of $28B of US government securities during the weekly period ending on Wednesday 6th August.

However, while $28B is the largest weekly increase ever in marketable US securities held by foreign central banks, it is not way out of line with earlier increases. For example, between January and July of this year there were 4 weeks during which foreign central banks made net purchases of more than $20B of US securities, and none of these accumulations had a big effect on the currency market. It should also be noted that the weekly volume on the foreign exchange market exceeds 10 TRILLION dollars, so it really makes no sense to assert that a $28B purchase could affect this market's trend so dramatically.

Of course, if you annualise last week's purchase of US securities you end up with a very large number (almost 1.5 trillion dollars), but it is not reasonable to annualise volatile weekly figures. Annualising the data from a much shorter time period is only appropriate in cases where the relatively short time period is, or is likely to be, representative of the entire year.

Having said all that, we are well aware that central bank manipulation of the currency markets occurs every week in one form or another, with one of the most popular forms being commonly referred to as "jawboning". The practice known as "jawboning" involves central bankers making statements designed to influence market prices by influencing the expectations of market participants. Last Thursday, for instance, the head of the ECB threw a wet blanket over expectations that Europe's central bank was likely to implement additional rate hikes over the coming months. This, we suspect, had a greater effect on exchange rates than the aforementioned purchase of securities, although we doubt that intervention of any form was the primary cause of the dollar's reversal.

The US$ is very under-valued relative to the euro on a purchasing-power-parity basis, so a lot of pressure has been required to PREVENT the dollar from rallying. And the main source of this pressure has, in our opinion, been strength in oil and other commodities. A self-reinforcing cycle has been in place over the past year, with rising commodity prices leading to speculative US$ selling and a falling US$ leading to speculative commodity buying. This self-reinforcing cycle has not ended, but when several high-profile commodities eventually buckled last month under the weight of either falling demand or rising supply the self-reinforcing aspect began to operate in the opposite direction. In particular, clear evidence that intermediate-term declines were underway in the commodity sector prompted US$ buying (or the unwinding of US$ short positions) and some US$ strength, which, in turn, exacerbated the declines in commodity prices and led to more US$ buying.

In summary, there is no need to concoct manipulation theories in order to explain the dollar's rebound. A more plausible explanation for the currency market turnaround is that the recent intermediate-term trend reversals in the commodity markets removed the pressure that had previously been preventing the US dollar from moving back towards fair valuation.

We think the dollar's move back towards fair valuation is still in its infancy, but the market looks over-extended in the very short-term so some consolidation is likely over the coming 1-3 weeks.

The US Dollar & The Gold Sector

Prior to the above, on August 10th, Saville wrote an editorial for Gold Eagle called The US$ & The Gold Sector. Here is a pertinent snip:

Many people will be asking the question: why is the US$ rallying when its fundamentals are so terrible? From our perspective, however, a more reasonable question is: why has it taken so long for the US$ to rally against the euro given that the US$ is extremely under-valued relative to the euro and the euro's fundamentals are just as bad?

The answer, we think, is that the currency market has believed that the US Federal Reserve would be as 'easy' as it needed to be to help the banking system through its crisis, while the ECB would continue to focus on minimising currency depreciation. We think the market was/is right to believe that the Fed will do whatever it takes to maintain the solvency of the major banks, but traders now appear to be coming around to the view that the ECB will also be loosening the monetary reins. Take away the interest-rate 'prop' and the euro suddenly becomes free to fall under the weight of its own over-valuation.

It is also worth mentioning that the recent sharp downturn in the world of commodities has probably had an important effect on perceptions, and hence on relative valuations, within the currency market. The reason is that with the prices of most commodities now in intermediate-term downward trends the decision-makers at the ECB should feel free to pay more attention to the serious economic slowdown currently underway, and less to the inflation problem.

So Much For The Manipulation Theory

On Saturday, while exchanging e-mails, Steve pinged me with the following idea:

Since I made those comments the Fed issued a report showing that there was a small decline in marketable securities held by foreign CBs during the week ending 13th August. This means that the best part of the US dollar's recent surge occurred while foreign CBs were net sellers. So much for that manipulation theory.

The Great Unwind

On Sunday, I received the following email from Steve:

I've been surprised by the magnitude of the sell-off in gold and particularly in gold stocks. I had expected that gold would get hit during the initial phase of a US$ rally, but not by as much as it has been hit. The amount of leverage employed in the gold market has obviously been a lot greater than I had thought, leading to gold getting caught up in what you've termed "the great unwind".

Gold isn't money (money is, by definition, the general medium of exchange, which gold clearly isn't), but it should be analysed as if it were money because its major trends are solely determined by monetary factors.


Group Think Not At Play

I had no idea what Saville's opinion was prior to someone e-mailing me his August 13th commentary. Thus Saville did not influence my thinking. Although several Minyanville professors I respect have been bullish on the dollar recently, several others I also respect have not. And I was surprised to learn that Marc Faber had still other reasons to be bullish on the dollar as noted in Marc Faber - Bullish On The US$, Bearish On Commodities.

It is easy (and dangerous) to seek out opinions that are similar to your own. However, independent analysis as opposed to "group think" seems to be the force at play here.

Dollar Bears Need To Face The Facts

It's time for dollar bears to face the facts. There are many reasons for the US dollar to rally on fundamentals alone. Add in extremely bearish sentiment and expectations that Trichet was going to keep hiking rates to the moon and there was a powder keg of pent-up demand for dollars waiting to explode and it did.

There is simply no real evidence that a small manipulation in currencies played a significant role in the recent dollar rally or the gold decline no matter how loud manipulation theorists shout. Correlation is not causation, no matter how much anyone wants to believe.

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