Central Bank dollar holdings - good for gold, bad for dollar?

The latest figures from the US Department of the Treasury show not only how the US liabilities to other central banks have rocketed by 31% over the eleven months to May, but also that the balance of the maturities of these liabilities is shifting towards the short end as major counterparties increase their flexibility and de facto demonstrate their increasing levels of concern about over-exposure to the dollar. The primary reason for the shift has been a massive absolute increase in short-dated instruments and a much smaller change in the longer-dated instruments, suggesting that a good part of the shift has been as a result of the QE exercises.

This is, in principle, good for gold, not because it implies an outright reweighting towards gold in major nations' foreign exchange holdings, as that would be wholly unfeasible and market-disruptive, but because a potential erosion in global dollar confidence and a reluctance to retain dollar exposure almost always leads to increased willingness to invest in gold as a hedge not just against the dollar, but more partially as a hedge against risk and uncertainty.

In June 2008, the US' total foreign liabilities to the official sector amounted to $1.7 trillion, with Japan the largest holder at 36% of total and China holding 36%. Among individual nations (i.e. stripping out both oil-exporting bloc and Caribbean banking centres with 13% between them) the next largest three were Brazil (6%), Luxembourg (4%) and Russia (4%). Since then the picture has changed. China overtook Japan as the world's largest holder in September 2008 with a huge leap from $574 Bn to $618 Bn and by May 2009 Chinese holdings in these instruments were $802 Bn, with Japan holding $677 Bn and the UK, which shot into third position with $164 Bn. In fact the UK's holdings tripled over the period.

The current pecking order, then, is China with 35% of total, followed by Japan (30%), the UK (7%), Brazil (5%) and Russia (5%) with the five between them accounting for 83% of total.

In June 2008 China's short-dated US holdings amounted to $15.2 billion, or just t3% of total. By end-May they had shot up to $210 Bn, or 26% of total, which is also the proportion held by the world as a whole. Russia is maintaining the most flexibility with 49% of its exposure in short-dated instruments ($61 Bn) and Brazil's short-dated balance is now 8% against 1% in June 2008. Japan and the UK have maintained broadly unchanged structures over the period and have continued to increase their longer-dated holdings. China, Russia and Brazil have been more reluctant to add to their longer-dated instruments.

So what does this signify? It is well-documented that Chinese politicians and bankers have been regularly expressing concern over dollar-heavy exposure and have recently been espousing an increased role for the SDR in the international system; it would seem that they are putting their gearing up for - or are already implementing - shifts in the balance of their international assets, although as always with central bankers the moves are likely to be gradual.

The trigger may be in 2011 when the voting powers of the IMF members are up for adjustment and there is a widespread push for the new voting tariffs more accurately to reflect international economic power. This may well also be the time when, if it comes about, the structure of the SDR is changed.

Although as noted above none of this necessarily signifies a major tonnage shift towards gold, it may herald a fresh shift in sentiment with respect to the implications for the dollar's role in the system. This is almost bound to lead to gold sustaining a yet higher profile, if only in the debate about reserve currencies and their relative merits.

Meanwhile the IMF is discussing the likely mechanics of the sale of those much-discussed 403.3 tonnes of gold that it is proposing to sell to aid the international funding process. The vote is likely to be taken in September, but with the new Central Bank Gold Agreement also under negotiation and due for implementation on 27th September this year, the logistics are likely to be decided before then. It is not yet known whether the IMF will become a signatory to the next CBGA or whether it will take up an existing allocation from other signatories with no large-scale sales intentions, but it has been made abundantly clear that any such sale fron the Fund is expected to be under the auspices of a CBGA.

And it is perfectly possible that it may all yet go out in an off-market transaction to another central bank or banks.

US & Canada

The US Q2 2009 GDP declined at a less-than-expected 1.0% q/q annualized rate after a downwardly revised 6.4% q/q contraction in Q1, according to advance Q2 GDP data released by the Commerce Department. The Q2 GDP shrank 3.9% y/y, the largest drop for any year in the post-WWII era. The largest negative drags on the Q2 GDP were business investment, personal consumption, home building, and inventories. The Q2 personal consumption declined at a more-than-expected 1.2% q/q annualized pace after Q1's 0.6% q/q increase. The strongest components of the Q2 GDP were international trade, which added 1.4 percentage points to the GDP growth rate, and government spending, which added 1.1 points. The GDP price index was up at a 0.2% q/q annualized rate in Q2, up 1.5% y/y.

US employment costs rose a slightly more-than-expected 0.4% q/q in Q2 2009 after a record-low 0.3% q/q increase in Q1, according to a Labor Department report.

The Chicago business barometer increased to 43.4 in July, slightly more than our forecast and the highest reading since September 2008, from 39.9 in June, indicating the rate of contraction in business activity slowed this month, according to the Chicago Report by Kingsbury International, Ltd. and the Institute for Supply Management – Chicago, Inc. The production index increased to 43.3 in July from 39.3 in June; the new orders index rose to 48.0 from June's 41.6; the employment rate of decline slowed; the inventories index was at 25.4, the lowest reading since mid-1949; and the price paid and order backlog indexes declined, according to the Chicago report.

Canada's GDP fell a more-than-expected 0.5% m/m in May, a tenth consecutive month-on-month contraction, after a downwardly revised 0.2% m/m decline in April, data from Statistics Canada showed. The GDP dropped 3.5% y/y in May, the largest contraction since October 1982.

Dollar Index at Key Support

The dollar fell in NY trading Friday as a government report showed the US economy contracted less than expected in Q2 2009. Private inventories declined sharply for a second quarter, making it likely that the Q3 2009 GDP will show a strong economic expansion as the record drawdown of inventories will set the stage for increased production. The S&P 500 rose 1.73 points to 988.48, moving closer to the 1000 resistance on economic recovery optimism. The euro gained on improved risk sentiment and better-than-expected European labor market statistics. The GBP/USD surged above the important 1.66 resistance. The yen rose against the dollar but fell versus most other key currencies. The commodity currencies advanced. The Australian dollar rose to the highest level since September. The Reserve Bank of Australia will likely keep its key interest rate unchanged at 3.00% early next week. The Canadian dollar climbed to the highest level since October.

The dollar index fell sharply on Friday. The dollar index, trading inversely with the stock market and risk appetite, is testing the lows set in June and December. The index peaked in the beginning of March, which coincided with the US stock market's low. The index then traded sharply lower as stocks rallied. During June's stock-market consolidation, the dollar index moved sideways. If the 78-area support is broken, the index will drop significantly.

Dollar retreats as shares rally

TOKYO (Agencies): The dollar retreated in Asian trade Friday as a rally in global shares and metal prices encouraged investors to snap up riskier currencies that are closely tied to volatile commodities markets. The dollar slipped to 95.43 yen in Tokyo morning trade from 95.51 in New York late Thursday. The euro firmed to 1.4084 dollars from 1.4063 and to 134.40 yen from 134.33. Global stock market gains and a jump in industrial metals prices drove up the currencies of countries whose economies rely heavily on exports of commodities, such as the Canadian, Australian and New Zealand dollars. The bounce in markets "reflected growing confidence in an economic recovery," NAB Capital strategist John Kyriakopoulos wrote in a note. "Improved investor risk appetite weighed on the 'safe haven' US dollar and yen," he added. Risk aversion eased after Wall Street powered higher on upbeat corporate earnings results and a broker upgrade of General Electric, propelling the main indexes to fresh 2009 highs. Barclays Capital analysts said that risk sentiment would remain the dominant driver of the commodity currencies, but upcoming Chinese and US factory data and American jobs numbers risk taking the steam out of the market. Investors were looking ahead to US second-quarter gross domestic product (GDP) figures due later Friday. New claims for unemployment benefits in the United States rose in the past week to 584,000, according to a weekly government update that nonetheless showed some signs of improvement in a weak labour market.

US Dollar Teetering on the Edge of the Abyss after a Better GDP Release?

It was an extremely dangerous way to end the week. The US dollar has held very close to general support for some time now; but the ante was upped when steady selling pressure pushed the single currency to its lowest close on a trade-weighted basis since September 30th. We can see the same level of intensity among the individual majors. EURUSD is just below its June highs of 1.4340 while GBPUSD managed to close at a nine-month high well above range resistance at 1.6600. Despite this tremendous pressure and the relative records, this is not a definitive bearish break for the greenback. When liquidity returns early Monday morning in the Asian session, speculators will immediately go back to work on trying to jump start the next major trend. For those that have dollar exposure or are waiting for the dollar to make its move, it will be an open not to be missed.

How did we come to this point? When did the dollar’s feeble attempts to rebound from its lows give way? The currency fell 1.2 percent through Friday’s session - the largest decline and absolute move since June 23rd - following the release of what at first glance seemed to be a better-than-expected outcome for the advance reading of second quarter growth. The Bloomberg consensus was projecting a tempered 1.5 percent pace of annualized contraction following what was initially a multi-decade, 5.5 percent plunge. Given this benchmark, the 1.0 percent decline that crossed the wires seemed to be a big step closer to realizing expectations for the inevitable return of positive growth. However, just below the surface, the cracks were clearly visible. The peak of the recession marked by the previous quarter was distended to a 6.4 percent malaise that matched the worst the world’s largest economy had seen since 1980. What is far more disconcerting (but not yet fully appreciated) is that the foundation for this recovery is unstable. Of all the major categories of economic activity, only government spending was rising. Personal consumption dropped 1.2 percent, exports 7 percent and private investment 20.4 percent. Fiscal stimulus is already reaching its limits and the cries to reign in aid and work down the deficit are growing louder. Without consumer spending (which accounts for approximately 70 percent of activity), the economy will not easily be able to recover on its own power. Expect to see the terms ‘L’ and ‘W’-shaped recession used more often.

The long-term outlook is highly uncertain and certainly bearish; but come next week, market participants may not immediately be concerned with underlying trends. With the dollar backed up to a technical wall, speculators will look to either force a break or offer a modest relief rebound first thing. The longer the currency holds to its technical floor, the more violent the eventual market shift could ultimately be. There is plenty of event risk on the docket; but its influence on the critical decision of breakout or reversal is likely low. ISM manufacturing and service sector surveys, consumer credit, personal spending and income are all notable indicators; but the NFPs once again holds the greatest clout. There are many indicators that hint at stabilization and eventual recovery; but none are as truly influential and accurate as the monthly payrolls report.

Forex Weekly Trading Forecast

Japan to cap forex margin

TOKYO (Agencies): Japan’s foreign exchange margin traders will have their leverage capped at 25 times collateral two years from now, the government said on Friday, a move that could curb retail investors’ zest for currency speculation. The Financial Services Agency said leverage would be capped at 50 times starting in August 2010, and at 25 times starting a year after that, in line with a proposal it unveiled in late May. That would be a big cut for some brokers who offer leverage of 400 times or more, and for margin brokers in general. Foreign exchange margin trading, which allows investors to make large bets with relatively small amounts of money, has boomed in the past few years as Japanese households, dissatisfied with puny interest rates at home, looked abroad for higher yields. In a sign of their growing clout, a Bank of Japan report said last year that foreign exchange margin trading in Japan may account for 10 percent of all yen spot trades conducted globally each day.