Sunday, December 20, 2009

Don't trash our US Treasury reserve holdings, or else...

Another gem found on Safe Haven is written by Clive Maund, a gold bug. His article is making several observations that are important to be alert to. He is in a small number of market watchers calling for a much higher dollar. Most interesting, is the discussion that the stock market is subordinate to the Treasury market and is therefore a sacrificial lamb anytime protection of the dollar is needed. Finally, his article includes an interesting technical analysis of gold and it lends support to his other points, such as a strong dollar. This is certainly effective at helping me better appreciate the job in front of Bernanke.

Big overseas Treasury holders such China and Japan are believed to have "strong-armed" the US in the recent past behind the scenes and essentially said "You either quit undermining your currency and defrauding us with your zero interest rate policy or we are going to dump them, big time, and collapse the Treasury market." The Treasury market is the "aorta" of the US, which involves swapping essentially worthless paper for the goods and services of countries that are dumb enough to buy them, thus allowing the US to live way beyond its means running continuous massive deficits. It is viewed by the administration as infinitely more important than the stockmarket, which is small in comparison. It is thus clear that if it is necessary to sacrifice the stockmarket by raising interest rates to rescue the Treasury market, then that is what's going to happen.

The rising Treasury yield curve, which has recently become very steep is indicating that rate rises are in the pipeline. Smart Money has already got wind of this and has been stampeding to close out US dollar carry trade positions, hence the breakout and sharp rise in the dollar, and the plunge in gold. The ordinary Joe sat rustling his newspaper hasn't got the faintest idea of what is going on as usual. Given the magnitude of the US dollar carry trade positions that have built up this year on the back of unprecedented negative real interest rates in the US it should be obvious that a intensifying stampede out of them could easily drive a massive dollar spike, perhaps considerably larger than the one we saw last year, especially given the precarious condition of many countries in the European Union. In this situation commodities and the stockmarket will be trashed.

Those of you who may be deluding yourselves that the dollar's recent rise is just a countertrend blip might like to reflect on this article in The Wall St Journal titled Net Assets in Bullish US Dollar ETF Go Vertical in December . The point to appreciate here is that this asset buildup is not occurring at the end of a move, but rather at the start of it, and is thus a proxy for very high volume on the dollar breakout, indicating both that it is genuine and that the dollar is destined to go MUCH higher.