By Michael Pento | August 08, 2008 | 11:45 AM | 6 Comments
There can be no denying the recent sharp selloff in commodities coupled with a surge in the USD against most currencies. The reason has come from a watershed event in global markets. Investors worldwide have come to the realization that global economies are slowing and central bankers will be unable to continue their interest rate hiking campaigns any further and may soon start to cut rates. This epiphany has sent the USD up over 5% in less than one month on the widely followed US dollar index, which measures its relative value against our six major trading partners.
The US Central bank now has plenty of cover to keep rates low and can even drop rates further if it so chooses. The selloff in commodities and increase in the value of the dollar verses foreign currencies has provided the perception that inflation levels will fall and the purchasing power of our currency will increase.
What is not apparent to investors at this juncture is that precious metals should fare much better than the performance against other fiat currencies. This is true because the rise in the dollar is occurring not because of a change in our monetary policy but is solely the result of a change in the value of foreign currencies. The dollar is rising only if you measure its purchasing power against the other currencies whose central bankers are now being perceived as joining Ben Bernanke in the currency debasement derby. However, when measuring the dollar against real money-gold-there can be no such illusions. While the Fed must continue to pump in liquidity to rescue the banking sector, it is also debasing the value of its currency by vastly increasing its quantity. Since the supply of precious metals cannot be increased by fiat, their value increases even if the exchange rate of the USD rises.
The move in the dollar is completely based on the anticipation that lower rates are imminently coming from the Central Banks' of Australia, Europe and England just to name of few. The problem is that these banks have yet to embark on an interest rate reduction cycle, yet the value of their currencies are already pricing in a great portion of that move. And if you listen to the head of the ECB John Claude Trichet, his hawkish remarks show no such inclination to follow the same mistaken path as our Fed chairman.
It may or may not be true that foreign Central Banks will soon start to slash interest rates and give credence to the move in the FX market. What is known however is that Ben Bernanke has made it abundantly clear that he will fight a slowing economy first and worry about inflation later. With a faltering job market, falling home values and a banking system under duress, it is hard to believe the Fed will start to drain money from the economy. In fact, in light of the temporary rise of the USD and fall in commodity prices, it is more likely that the Mr. Bernanke will use that cover to lower rates rather than to raise them.
It is important to realize that the USD price of precious metals increases when the inflation rate of the dollar is greater than the inflation rate of mine supply. It is not reliant on the USD falling in value against a basket of other currencies. Although the optimal environment is for gold is to have both conditions exist, it is not necessary for the price of metals to increase. Investors should use this pullback in prices as a buying opportunity rather than a reason to sell.
Be sure to tune into Michael's weekly podcast Mid-Week Reality Check, with new episodes available every Thursday.
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