The New Bull Market in Gold

by Greg Canavan, Daily Reckoning It was ‘risk-on’ all around in global trade overnight. The major US indices were up nearly 1% on —get this — news of a cease-fire in Ukraine! Ignore the fact that markets never sold off on the escalating violence in the first place! But it sure makes for a good headline. More than likely, everything rallied because poor US retail sales held out the hope that the US Federal Reserve will hold off on interest rate rises. The eternal guessing game of will they or won’t they, and more importantly, when, continues. That’s good news for Aussie stocks, with the local market up strongly today. It reverses yesterday’s dose of reality where bad news on the employment front saw stocks sell off. But the ‘good news’ for our rentier economy is that poor employment data for December means the RBA could cut rates again in March. Yay! The dollar copped it, falling more than 0.5% against the greenback straight after the news. It bounced back overnight though and is now around 77.3 US cents. The unemployment rate jumped to 6.4%, the highest level since 2002. In seasonally adjusted terms, full time employment fell 28,100 in December. Record low interest rates haven’t propped up the employment market, but that hasn’t stopped calls for further cuts from the RBA to ‘do something’ about the unemployment situation. How lower interest rates are going to find jobs for thousands of engineering and construction workers is anyone’s guess. These are the biggest risk areas for job losses when the construction phase of many of the LNG plants winds down this year. They could retrain as baristas or real estate agents but that’s not exactly great for the economy. It doesn’t matter though, does it? When there’s only one tool in the box, you’re going to use it. But as I wrote yesterday, it’s going to cause all sorts of trouble in the long run. I also mentioned yesterday that the biggest threat to Australia from the ongoing euro crisis was a higher cost of funding for our banks. Soon after, I saw a headline on afr.com that suggested there are risks elsewhere too. ‘Big Banks lose crucial funding source’, the headline read. But it had nothing to do with Europe.

‘A $US90 billion funding line for Australian banks in the United States is beginning to close due to tough new financial crisis-inspired regulations, forcing local lenders to hunt for short-term money in more expensive funding markets. ‘The biggest US prime money market fund operator, Fidelity Investments, announced last week that three of its mutual funds will stop investing in bank paper and instead only buy government securities. ‘US money market funds, including Fidelity, Vanguard, BNY Mellon and State Street, are major investors in short term Australian bank paper with maturities of up to 12 months. ‘Australian banks had at least $US90.7 billion of short term debt issued to taxable US money funds as of January 31, according to Crane Data.’

Here’s how it works. US investors who don’t like the sound of 0% in a bank account put their cash in a money market fund. These funds invest in highly liquid short term securities, including Aussie bank paper. Not any more though. Banks will have to look elsewhere, and chances are the cost of funds will be higher than a US money market fund. Still, the banks won’t be too concerned. There is still plenty of liquidity around. But it is a gentle reminder of Australia’s reliance on foreign capital. The banking sector holds around $750 billion of foreign debt on its balance sheet, with short term funding accounting for just under half that amount. Last year’s Murray Inquiry recognised the risk of this reliance on offshore funding and made recommendations to strengthen the banks’ balance sheets. So far, none of these recommendations has been implemented, and with the government a bit of a basket case right now, none will be implemented for a while. All it will take is an external shock of some kind and it doesn’t matter how far the RBA cuts the cash rate…if foreign capital reassess risk and stops flowing here, even just a bit, the cost of credit to the household sector will rise. In such an environment, you’ll want to have a bit of financial insurance. In my view, gold is the best policy. Speaking of gold, the divergence of opinions of some of the editors here at Port Phillip Publishing has caused confusion. Don’t be confused though; this is just how an independent publishing company works. We publish ideas, not a company line. Recently, I wrote a bullish article on gold here in The Daily Reckoning. A day later, we published an article by Diggers and Drillers editor Jason Stevenson, who is bearish on gold. In short, Jason believes the US dollar bull market will knock gold down. But he’s talking about gold in predominately US dollar terms. My bullishness on gold stems from looking at it from an Aussie dollar perspective. On that front, it’s hard to argue against the bullish case. I’ll show you what I mean by that in a moment. Continue Reading>>>

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