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Saturday, Jan. 28, 2006

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Wilkinson's Edge
The Cutting Edge of Financial Analysis

Saturday, January 28, 2006

Falling Dollar, Striking Gold

Dear MoneyNews Reader,

The American dollar kicked off the week in a foul mood losing 2 percent to start the week.

That's no surprise to your currency- sniffing editor here at MoneyNews HQ in South Florida. However, the catalyst this week was not a weakening of the American economy, rather it was a double-whammy of comments from two leading members at the European Central Bank (ECB).

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Some weeks ago Jean Claude Trichet, president of the European Central Bank claimed that the rising price of oil would cause a slowing of the European economy.

That dashed euro bull hopes for a 2006 rally against the dollar. Until that point this was the widely held theory: rising interest rates would support the euro especially now that there's a clear end in sight to rate hikes from the Federal Reserve.

Then, into the fray jumped Messers Issing and Noyer, both ECB members. They told reporters over the weekend that the rising price of oil would likely raise more of a threat to inflation than it would impinge upon growth.

If that turned out to be the case then the ECB would definitely continue to raise interest rates. And the reaction to those comments from currency investors was to stockpile the euro, the yen and the pound.

As I'd commented some weeks ago in this very column, the euro is likely to be the currency of choice this year. My expectation is for a run back at the 2004 lows for the dollar at $1.36 and beyond. As such SectorTrade readers are already in the pole position for such an advance.

But apart from sending the dollar lower on the $1.9 trillion per day foreign exchanges, the move had repercussions on the commodities markets. Not least the weaker dollar helped push up the price of gold one again.

Gold has been on a tear over the last several years bolstered by under investment in mining activity and booming fundamental demand.

You see global demand for gold ranging from Arabic, Indian and Chinese demand for jewelry has risen.

Gold, well known for its protective qualities as a hedge against the falling value of printed government money (a.k.a. local currency), is becoming increasingly sought after as an asset by investors all over the globe.

Take a look at today's chart, which shows the percentage change in the value of gold as priced in five major currencies. Apart from the dollar, I have priced gold in terms of the Swiss franc, British pound, Japanese yen and the euro currency.

While the price of gold as measured in dollars is the clear winner, having risen roughly 35 percent since the February nadir in gold, Japanese investors are up 10 percent, while everyone else is up around 4 percent.

With international equity markets posting gains in 2005 of anywhere from 16 percent (U.K.) to 40 percent (Japan)it's entirely possible that investors might benefit from this established down trend in the dollar hitched at the hip with a rising price of gold.

Foreign equities might continue their ascent this year, but I'd be more willing to wager that gold will fare better in 2006.

Commodities Corner

Sticking with the theme of metals, let's also take a look at the price of platinum this week. (Yup, we have our eyes peeled here in South Florida!)

More than half of global demand for platinum comes from car-parts makers, who use it in the catalytic converter process in order to reduce emissions.

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With automotive demand growing in line with population pressures, in a world keener to clean up its act, platinum supply can't respond as quickly to demand as auto-parts makers would like.

Hence the price of platinum rose 13 percent in 2005. This week platinum futures traded at their highest level ever at $1,069 per ounce.

According to Johnson Matthey of the U.K., which produces catalytic converts, South African and Russian supply can't cope with overwhelming demand. In fact demand has outpaced supply in each of the last seven years according to a company source.

That's little wonder with car-parts makers using 3.9 million ounces in 2005 compared to 1.8 million ounces of platinum in 2000.

Also used in jewelry making, the precious metal is becoming increasingly popular with hedge funds seeking bigger and better returns than competing asset classes such as equities and bonds, which produced real returns of 4 percent and 2.8 percent respectively in 2005.

Hedge Funds

Some weeks ago I mentioned that hedge funds had a pretty mediocre 2005 with returns of just 9 percent, falling below the long-term average.

The wealthy investors that these exclusive funds serve are a pretty picky bunch, who have a track record of chasing the hot money and best returns.

Although the industry picked up a net $47 billion in fresh funds for the year as a whole, the fourth quarter saw an efflux of $824 million. The annual gain was the lowest in four years and the quarterly outflow was the first in a decade.

Funds of funds, whose assets account for around one-third of all hedge fund assets, attracted just $9.5 billion for the year. That's a heck of a lot less than the $33 billion in 2004 and the $59 billion in 2003.

Such funds invest in a series of individual funds in an attempt to lower risk rather than leaving themselves exposed to a single manager or asset class.

With fear and greed still guaranteed emotions in the world, hedge funds are unlikely to lose favor just yet. Individual managers at established funds continue to leave the fold and set up a fund of their own. Watch this space..

Have a great week! 

Andrew Wilkinson
Senior Newsletter Editor

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