Thoughts on Markets

Thursday, August 28, 2008

Dow Problems - China Supports Dollar - GLD Up

The above graph and the following were taken from the Agora Financial's Rude Awakening, but were originally from Casey Research:

"Q2 2008 – for the first time ever – the Dow Jones Industrial Average posted quarterly losses instead of earnings. The Dow's price-to-earnings ratio is now listed as 'Nil,' leaving Wall Street without its favorite valuation metric for blue chip companies.

"Citigroup and JP Morgan were pummeled for their subprime investments," continues David, "but the contagion of the credit crisis affected every balance sheet within The Dow. A couple of standouts amongst the wreckage were AT&T and Verizon, whose net incomes of $4B and $2B, respectively, were offset by huge losses in 'Investing Activities.' AT&T reported a loss of $11.3B, and Verizon lost $17.5B.

"These investment write-downs send huge amounts of capital to 'money heaven,' tempting some that have pitched a tent in the inflationist camp to wonder if we might be in for a major bout of deflation. But as Doug Casey so compellingly points out, today's fractional reserve banking system forces the government to pursue an aggressive inflationary agenda. They must continue to push more and more money into the system to maintain the appearance of economic growth, and to cover up the losses of these blundering blue chips."

That was not good news.

I wrote a few days ago that central bank intervention was the source of dollar strength. However, there are at least two reasons for the recent temporary strength of the dollar. The first was a concerted effort on the part of the U.S. Treasury, the Japanese Finance Minister, and the European Common Bank to support the dollar. The second reason is presented in the Telegraph article which follows:

From a stealth means of supporting the dollar by the Chinese

"Rule changes for commercial banks are acting as cover for exchange rate intervention, writes Ambrose Evans-Pritchard

China has resorted to stealth intervention in the currency markets to amass US dollars, using indirect means to hold down the yuan and ease the pain for its struggling exporters as the global slowdown engulfs the economy.

A study by HSBC's currency team in Asia has concluded that China's central bank is in effect forcing commercial banks to build up large dollar reserves, using them as arms-length proxies in a renewed campaign of exchange rate intervention.

Beijing has raised the reserve requirement for banks five times since March, quickening the pace with two half-point rises in late June.

This is having major spill-over effects into the currency markets because banks in China have been required over the last year to hold extra reserves in dollars rather than yuan. The latest moves have lifted the mandatory deposit from 15pc to 17.5pc of total lending since March.

"China has used the pretext of reserve requirement hikes to help slow yuan appreciation. We estimate that the PBOC [central bank] intervened by about $49.6bn in June," said Daniel Hui, the bank's Asia strategist."

This from Taipan Daily: "I am speaking of the Federal Deposit Insurance Corporation’s list of 117 “problem banks.” According to its latest press release, the number of banks that may have squandered away their depositors’ cash is up 30%, quarter over quarter, the highest it’s been in more than five years."

Did you get that? One Hundred Seventeen problem banks now and we have had nine failures this year already, and we are still counting. Is your bank on the list? Better check it out!

Before we leave the shaky banking industry, it seems that the FDIC may have to dip into the U.S. Treasury for funds to cover further bank failures. This was reported in the Wall Street Journal.

All three of our automobile manufacturers are almost on the ropes. News of this is wide spread and the discounts and low financing enticements lend credibility to this as fact. Are they "too big to be allowed to fail?" I bet they are considered as such and will be bailed out shortly as was Chrysler in the "distant" past. Folks, that will mean more dollars printed or generated by computer blips.

Back to China, we find that China has some $1,800 Billion (Yes, with a "B.") in reserves. Think of that! Any change in this amount of reserve will have a world wide impact upon currencies. What about the threat that is to world. Talk about having a big bat to swing!

U.S. Industrial Production came in at +1.3%, duplicating the figure for June. This appears to be mostly from non-defense spending. However, it is likely due to the stimulus package of "gifts" to citizens. Remember, though, these "gifts" have been spent and will not be available for spending in the 3rd and 4th quarters. Will the Christmas season spending make up the difference? Possibly, but the world economy is slowing and central banks have expressed a greater concern about this than inflation.

Using GLD as a proxy for gold, we can see in this weekly graph that gold is above the 200 Day Moving Average and seems to be headed for the 50 Day Moving Average. A break through of the 50 day would indicate more strength. Probably, this will happen next week after the 3 day weekend.

Gustav is still on the way and having an impact upon the price of oil. Gold is at 837.40 and silver at 13.87 now. Both are up for the day, but it is early in trading. The options have closed and now for the fall, both are likely to be traded a bit more freely. We are looking forward to that time.

Continue to rest in the promises of our Sovereign God. We must always pray for His wisdom and praise Him continually for His gracious care.

Best to each, Doug


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