The euro and the yen have quietly usurped the dollar as the world’s favorite haven. Investors have been increasingly turning to the euro and yen to fund carry trades, leading to the greenback’s underperformance during bouts of risk aversion since 2014. Foreign-exchange havens including gold outperformed the dollar on a volatility-adjusted basis when the bank’s Global Financial Stress Index showed market dislocations over the past three years. Before 2014, the three-month risk reversal for haven exchange rates relative to the U.S. currency as a percentage of implied volatility — another measure of volatility — was consistently negative.
Principal component analysis, a way to isolate the drivers of a given trend, shows that the yen tends to consistently appreciate when sentiment in the U.S., euro area and China sours, while gold looks like a good hedge on developed-market stress. The dollar, meanwhile, tends to sell off during deteriorating sentiment toward the U.S. economy — food for thought if there’s a redux of the debt-ceiling debacle at the end of the year.
Stronger than expected U.S. data helped the greenback shake off its initial weakness to end the New York trading session much closer to its highs than lows. The dollar did not manage to turn positive against the euro, sterling and the commodity currencies but it enjoyed some gains versus the Japanese Yen and Swiss Franc. The dollar should actually be trading much higher given the unexpected strength of the non-manufacturing ISM report. Service sector activity grew at its fastest pace in 13 years as Hurricane Harvey caused a sudden slowdown in supplier delivery times. Most importantly, the employment component of the report increased which indicates that instead of losing jobs, the services sector, which is the largest part of the labor market added jobs at a faster pace in the month of September. According to ADP, corporate payrolls rose by only 135K compared to 228K the previous month but while job growth slowed, investors had braced for an even softer report. So the fact that it was in line is good news for the dollar. These 2 reports will leave investors hoping for stronger job growth. Economists are currently calling for an increase of 80K jobs in September, down from 156K jobs in August. To put this into perspective, after Hurricane Katrina, the Bureau of Labor Statistics reported a loss of -35K jobs but it was later revised to an increase of 67K jobs. It is difficult to say how much of an impact the hurricanes had on job growth but a rebound and upward revision is certain for the following month so investors could choose to discount and look beyond September’s soft report. Regardless, with ISM surprising to the upside, we expect the dollar to hold onto its gains ahead of the jobs report.
Despite the US dollar’s strength, the euro ended the day higher against the greenback thanks to stronger than expected Eurozone PMIs. Like the manufacturing sector, service sector activity was revised higher for the Eurozone, offsetting the decrease in retail sales. Catalonia announced that it will take steps on Monday to declare independence from Spain despite King Felipe’s rare speech calling the situation extremely serious and accusing pro-independence leaders of having unacceptable disloyalty towards the powers of the state. The Spanish government could still take steps to prevent independence and we think they will but for the time being, investors are looking beyond these dangerous political risks to the next European Central Bank meeting. We still think EUR/USD could still take another hit from the political crisis in Spain but as the monetary policy decision nears, buyers will swoop in quickly. Tomorrow’s ECB “minutes” should support the euro as the central bank made it very clear last month that the bulk of policy decisions will be made in October.
Sterling was one of the day’s best performing currencies. After falling for the past 3 days straight, we’ve finally seen a positive one courtesy of the UK PMIs services report. As we wrote in yesterday’s note, services PMI may not follow manufacturing lower because retail sales and consumer confidence improved last month. Thankfully that was the case as the uptick in the index to 53.6 from 53.2 helped to stem the slide in the currency. It also allowed the composite index to tick up to 54.1 from 54 instead of falling like economists anticipated. Still, according to our colleague Boris Schlossberg, “the underlying data suggested that troubles exist in the largest sector of UK economy. Markit noted that, “Service providers commented on subdued business-to-business sales and delayed decision-making on large projects in response to Brexit related uncertainty. Reflecting this, latest data indicated that overall new business volumes expanded at the slowest pace since August 2016.”
All 3 of the commodity currencies appreciated against the greenback today with the Australian dollar leading the gains despite stronger U.S. data and weaker Australian data. According to the latest report, service sector activity slowed in the month of September with the PMI index dropping to 52.1 from 53. Yet investors found relief in the World Bank’s upgraded GDP forecasts for China. The organization raised its China growth forecast by 0.2% from 6.5% to 6.7% in 2017 as they feel that the “economic outlook for the region remains positive and will benefit from an improved external environment as well as strong domestic demand.” The Australian dollar will remain in focus this evening with retail sales and the trade balance scheduled for release. The recent slowdown in manufacturing activity suggests that trade activity may have slowed and according to PMI services, retail sales contracted for the sixth consecutive month on growing competition from online and offshore sellers. They also felt that spending was being dampened from slow wage growth and rising housing/energy costs. None of this is good news for AUD/USD and could drive the currency pair lower once again. The New Zealand dollar shrugged off yesterday’s decline in dairy prices to trade higher. New Zealand data was mixed with commodity prices rising but house price and job advertisement growth slowing. NZD/USD is testing the 200-day SMA. While this may be a natural support level, the positive bias in the U.S. dollar could drive the currency pair below this key technical level.
Last but certainly not least USD/CAD ended the NY trading session below 1.25. This is significant because it marks the 6th consecutive trading day that the pair has struggled around this key level. With each passing day, the risk of a deeper correction grows but at the same time the longer USD/CAD remains below 1.25, the stronger a breakout will be. Speculators are aggressively short USD/CAD so a short squeeze is still a risk. Looking ahead Canada is scheduled to release its trade balance tomorrow and the drop in the IVEY PMI index suggests that the deficit could widen. – Kathy Lien
Countries around the world would soon stop trading commodities like oil in the US dollar, something we’re already seeing with China, Russia, Iran, and Venezuela, all of which are preparing non-dollar, gold-backed mechanisms of exchange.
This trend, according to Katusa in a must see interview with Future Money Trends, will only continue to weaken the U.S. dollar going forward and the result will be a massive capital flight to gold in coming years:
I think we’ll have a near term bounce on the US dollar… then it’s going to be very weak… and then it’s going to go much, much lower… With China and Russia working together to de-dollarize the US dollar starting with oil, which is the biggest market… and then all the other commodities.
You’re going to start seeing a massive unwind of these US dollars in the emerging markets.
When that money comes back… which it will… and the world starts cluing in that the emerging markets need gold to convert the Yuan and the Ruble and all these different factors, you’re going to see a massive rush for gold.
Katusa notes that he is preparing to “load up” on gold-based assets as the dollar strengthens and puts additional pressure on gold prices, but says that by next year major fund managers will start moving capital back into precious metals in response to dollar weakness, global de-dollarization and economic crisis:
Everybody wants to rush in when something’s exciting… but you take your position before the massive flow of money… I think we have a near term dead cat bounce for the US dollar… which will mean we’re going to have a little bit of weakness here in gold in the near term… the next six months is my time to load up.
…And when the funds flow come in… it’s going to be the equivalent of Niagra Falls coming through your garden hose.
The geo-political realignment taking place now stands to upend the financial and economic systems as we know them. This shift will not come without crisis and panic. The time to position yourself in gold-based assets is now. – Mac Slavo
Many Daily Reckoning readers are familiar with the original petrodollar deal the U.S made with Saudi Arabia.
It was set up by Henry Kissinger and Saudi princes in 1974 to prop up the U.S. dollar. At the time, confidence in the dollar was on shaky ground because President Nixon had ended gold convertibility of dollars in 1971.
Saudi Arabia was receiving dollars for their oil shipments, but they could no longer convert the dollars to gold at a guaranteed price directly with the U.S. Treasury. The Saudis were secretly dumping dollars and buying gold on the London market. This was putting pressure on the bullion banks receiving the dollar.
Confidence in the dollar began to crack. Henry Kissinger and Treasury Secretary William Simon worked out a plan. If the Saudis would price oil in dollars, U.S. banks would hold the dollar deposits for the Saudis.
These dollars would be “recycled” to developing economy borrowers, who in turn would buy manufactured goods from the U.S. and Europe. This would help the global economy and help the U.S. maintain price stability. The Saudis would get more customers and a stable dollar, and the U.S. would force the world to accept dollars because everyone would need the dollars to buy oil.
Behind this “deal” was a not so subtle threat to invade Saudi Arabia and take the oil by force. I personally discussed these invasion plans in the White House with Kissinger’s deputy, Helmut Sonnenfeldt, at the time. The petrodollar plan worked brilliantly and the invasion never happened.
Now, 43 years later, the wheels are coming off. The world is losing confidence in the dollar again. China just announced that any oil-exporter that accepts yuan for oil can convert the oil to gold on the Shanghai Gold Exchange and hedge the hard currency value of the gold on the Shanghai Futures Exchange.
The deal has several parts, which together spell dollar doom. The first part is that China will buy oil from Russia and Iran in exchange for yuan.
The yuan is not a major reserve currency, so it’s not an especially attractive asset for Russia or Iran to hold. China solves that problem by offering to convert yuan into gold on a spot basis on the Shanghai Gold Exchange.
This straight-through processing of oil-to-yuan-to-gold eliminates the role of the dollar.
Russia was the first country to agree to accept yuan. The rest of the BRICS nations (Brazil, India and South Africa) endorsed China’s plan at the BRICS summit in China earlier this month.
Now Venezuela has also now signed on to the plan. Russia is #2 and Venezuela is #7 on the list of the ten largest oil exporters in the world. Others will follow quickly. What can we take away from this?
This marks the beginning of the end of the petrodollar system that Henry Kissinger worked out with Saudi Arabia in 1974, after Nixon abandoned gold.
Of course, leading reserve currencies do die — but not necessarily overnight. The process can persist over many years.
For example, the US dollar replaced the UK pound sterling as the leading reserve currency in the 20th century. That process was completed at the Bretton Woods conference in 1944, but it began thirty years earlier in 1914 at the outbreak of World War I.
That’s when gold began to flow from the UK to New York to pay for badly needed war materials and agricultural exports.
The UK also took massive loans from New York bankers organized by Jack Morgan, head of the Morgan bank at the time. The 1920s and 1930s witnessed a long, slow decline in sterling as it devalued against gold in 1931, and devalued again against the dollar in 1936.
The dollar is losing its leading reserve currency status now, but there’s no single announcement or crucial event, just a long, slow process of marginalization. I mentioned that Russia and Venezuela are now pricing oil in yuan instead of dollars. But Russia has taken its “de-dollarization” plans one step further.
Russia has now banned dollar payments at its seaports. Although these seaport facilities are mostly state-owned, many payments, like those for fuel and tariffs, were still conducted in dollars. Not anymore.
This is just one of many stories from around the world showing how the dollar is being pushed out of international trade and payments to be replaced by yuan, rubles, euros or gold in this case.
I believe gold is ultimately heading to $10,000 an ounce, or higher.
Now, people often ask me, “How can you say gold prices will rise to $10,000 without knowing developments in the world economy, or even what actions will be taken by the Federal Reserve?”
It’s not made up. I don’t throw it out there to get headlines, et cetera.
It’s the implied non-deflationary price of gold. Everyone says you can’t have a gold standard, because there’s not enough gold. There’s always enough gold, you just have to get the price right.
I’m not saying that we will have a gold standard. I’m saying if you have anything like a gold standard, it will be critical to get the price right.
The analytical question is, you can have a gold standard if you get the price right; what is the non-deflationary price? What price would gold have to be in order to support global trade and commerce, and bank balance sheets, without reducing the money supply?
The answer is, $10,000 an ounce.
I use a 40% backing of the M1 money supply. Some people argue for 100% backing. Historically, it’s been as low as 20%, so 40% is my number. If you take the global M1 of the major economies, times 40%, and divide that by the amount of official gold in the world, the answer is approximately $10,000 an ounce.
There’s no mystery here. It’s not a made-up number. The math is eighth grade math, it’s not calculus.
That’s where I get the $10,000 figure. It is also worth noting that you don’t have to have a gold standard, but if you do, this will be the price.
The now impending question is, are we going to have a gold standard?
That’s a function of collapse of confidence in central bank money, which is already being seen. It’s happened three times before, in 1914, 1939 and 1971. Let us not forget that in 1977, the United States issued treasury bonds denominated in Swiss francs, because no other country wanted dollars.
The United States treasury then borrowed in Swiss francs, because people didn’t want dollars, at least at an interest rate that the treasury was willing to pay.
That’s how bad things were, and this type of crisis happens every 30 or 40 years. Again, we can look to history and see what happened in 1998. Wall Street bailed out a hedge fund to save the world. What happened in 2008? The central banks bailed out Wall Street to save the world.
What’s going to happen in 2018?
We don’t know for sure.
But eventually a tipping point will be reached where the dollar collapse suddenly accelerates as happened to sterling in 1931. Investors should acquire gold and other hard assets before that happens. – Jim Rickards
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