Please, click here to read this article in pdf format: december-7-2009

It’s Monday morning and I expect that you will have already digested Friday’s action, that you will have had enough time during this weekend to think over what just happened two days ago.

The release of US labor market data gave a final touch to the discussion over whether there is or not an ongoing recovery, with weak consumption. The so-called and feared jobless recovery, where consumption would remain weak as unemployment remained high, seems to have faded in the mind of investors. With this, the expectation of “low rates for longer than expected” seems to have muted into a “low rates for a certain and limited period”. Gold sold and sold dramatically, dropping from $1,226/oz intraday Thursday to $1,049 intraday Friday. Of course, the S&P TSX Composite Index (Canada) took it on the chin.

Today, instead of giving answers, I want to suggest some observations that bring up what I think are relevant questions:

-Interestingly enough, the Euro lost against the Canadian dollar on Friday. At the close of Thursday, a Euro bought 1.5910 CAD. At the close of Friday, a Euro bought 1.571. However, European equity markets had gained over 1%, while the S&P Toronto Stock Exchange Composite Index had lost -1.08%. If we remember that on Thursday, the European Central Bank had decided to leave interest rates unchanged… What do we make of this?

-Gold held very well immediately after the announcement that Dubai was considering restructuring the debt of Dubai World. Yet, some mildly positive news out of the US labor market sent gold 5% down intraday on Friday. At “A View from the Trenches”, I have held that gold’s price has been a function of the degree of coordination in global monetary policy. But, we can still ask ourselves if gold is actually a hedge against inflation or against chaos…

The US yield curve steepened on Friday, signaling “wise” money is getting ready for a change. If commodities sold off on Friday on fears of an earlier than expected increase in interest rates, why would that negatively have affected the Euro? Would Europeans not happily increase rates too?

From a fundamental perspective, the disparity in the USD and Euro outlook can only be justified if one assumes that productivity increases will match interest rate increases better in the US than in the Euro zone. Note that I did not say that productivity would change faster or slower in the US vs. Euro area. I said that the changes in productivity would match better the changes in interest rates in the US, rather than in Europe. Now…how true is this statement? Is the US increasing productivity or is the USD only lagging other currencies, given that it had been massively oversold? There are problems in the Euro zone, with countries like Greece, whose fiscal deficits are unsustainable…But we could also talk about California. How can we blindly adhere to a fundamental view these days? How can we ignore the technical damage done to gold on Friday?

The end of the year approaches and I do not think we can see catastrophic moves. I will wait and see. But come January, and you’d better be ready to fly low, because it will be open season…

One last thought:

In 2009, Gold was NOT profitable when there was global coordination to lower rates. Gold became profitable when the coordination broke, with central banks keeping rates low, while others increased them. If the Fed started to increase rates sooner than later, would that increase be “coordinated” with other countries? I think the answer is yes, but not because the Fed sought to coordinate, but because the rest of the world would play along. According to our Thesis No. 2, with this coordination, gold should underperform. Thesis No. 2 is being tested right now.

Martin Sibileau.