THURSDAY MAY 13, 2010

The new reserve currency.

Since the market bottomed in March of 2009, the "risk" trade has worked.  Investors could borrow at very low rates and buy assets with a higher risk/higher return profile.  Stocks and commodities were the big beneficiaries of this trade.  In particular, the commodity trade was believed to be the perfect "weak" dollar play.  The massive deficit will require the Feds to issue huge amounts of debt, which in turn will weaken the dollar.  Buying commodities was viewed as a way of hedging the pending weak dollar.  Interestingly, in the last two weeks, that trade has changed.

The dollar is a beneficiary of the Greek tragedy playing in Europe.  The bailout of Greece has highlighted the need for draconian corrective action to repair the indebted balance sheets of most European governments, not just Greece.  In the last two days, both Spain and Portugal have announced "crisis taxes" and spending cuts to fight their own fiscal woes.  While necessary, these actions will have the unfortunate effect of slowing the already lethargic European economy.  The immediate impact is the flight out of the Euro currency...into the U.S. dollar.   Suddenly, the "risk" trade doesn't work as well.

However, there seems to be more going on than meets the eye. In the two weeks since the Greek tragedy bailout, the price of a barrel of oil (and most other industrial commodities) is down 13%, from a high of $86.84 to $75.30.  Yet, at the same time, the price of an ounce of gold has increased 9%, to 1233 from 1136.  Why the divergence?  If this was a slowing economy trade, wouldn't gold go down as well?

In general, commodities have lost value on the perception that the global economy is set to slow.  Austerity will be the rule in Europe.  China has taken steps to slow its economy and hopefully prevent its own potential real estate bubble.  Australia has raised its benchmark interest rate.  In the U.S., our economy is faced with the end of stimulus and higher taxes at year end.  Yet, Gold has continued its rise.  It is more than a weak economy story.  While the dollar has naturally strengthened in the aftermath of Greece, it seems global investors are also investing in gold as a reserve currency.  Yes, for the moment, the dollar looks better than the Euro, but is that saying much?  Is being the best of the worst enough?  In short, the movement into gold is demonstrating of a lack of confidence in the U.S. dollar.  Investors are concluding that the U.S. 's own fiscal woes are problematic and are buying gold in lieu of dollars. 

In the short-term, the dollar will remain the reserve currency.  However, gold seems to be sending a signal that it may not be in the future.  I hope Washington takes notice.

POSTED AT 1899-12-30 14:12:00.0

KEN ENTENMANN, CFA
SENIOR VICE PRESIDENT AND
THE DIRECTOR OF INVESTMENT MANAGEMENT SERVICES

Ken is a Senior Vice President and the Director of the Trust and Investment Services at Alliance Bank, N.A. He has 23 years of investment experience and oversees the management of assets totaling $1 billion. He holds a B.S. in Applied Economics and Business Management from Cornell University and an M.B.A. from the William E. Simon Graduate School of Business Administration at the University of Rochester. He has also earned his Chartered Financial Analyst designation. He is a member of the Executive Committee of the Trust Division of the New York Banker's Association. He is also a director of the Central New York Community Foundation.

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