Gold, China, and the dollar

While I was en route to China, somewhere over the Sea of Japan, gold hit a record high on ‘concerns’ about the long-term value of the dollar.

Frankly, 1974 was probably the time to be ‘concerned’ about the long-term value of the dollar.  The remaining institutional investors who are only now finding reasons to be concerned about the dollar are probably the same ones that thought Ford and Fannie Mae were bargains last year.

The dollar is likely having such a volatile day thanks to this article from the UK’s Independent. The article asserts that Russia, China, and the Gulf Arab states have been holding secret meetings to plan a transition away from dollar-priced oil.

According to the article, which cites ‘Arab and Chinese banking sources in Hong Kong,’ the plan’s deadline for complete transition is 2018.  This date makes sense considering that the longest-dated oil futures contracts expire in December of that year… but are the claims legitimate or simply rumor?

Who knows. Saudi and Russian authorities have already denied the newspaper’s allegations, but this is to be expected.

While gold may be getting a friendly bump thanks to the Independent’s article regardless of whether the claims are true, it is unquestionable that the dollar’s long-term value is heading south.

On the plane ride to China, I was reading a rather interesting “Trade and Development Report” published recently by the United Nations.  The report provides concrete data for how governments around the world have reacted to the financial crisis.

One of the things that caught my interest in the report was a table on page 66 tallying fiscal stimulus programs and government bank guarantees as a percentage of GDP.

The United States, for example, has backed its banking sector with a whopping 81.1% of GDP.  The United Kingdom, Sweden, Netherlands, and even Japan ring in at 81.7%, 70.2%, 46.5% and 22.3% respectively.

“Developing” nations like Brazil, Chile, Taiwan, Philippines, and Thailand? 0.0%. China came to the table with 0.5%.

The data certainly begs the question– which of these groups should actually be considered ‘developed’?

Ironically, most western ‘developed’ governments, led by the United States, have only been able to make these multi-trillion dollar bank guarantees because of the generosity and savings provided by ‘developing’ countries through US Treasury purchases.

‘Developing’ countries are weary of this model– Chinese and Taiwanese no longer live for the pleasure of exporting their products to the West in the hopes of being paid in US dollar IOUs.  Consequently, the concept of a new reserve currency is one that has legs and will in all likelihood become a reality.

If, under influence from western governments, the IMF decides to not go along with a new reserve currency scheme, the strongest developing nations will likely conspire to create their own internal mechanism.  The US and Europe will be forced to go along with it as a matter of necessity.

This is why gold and silver have such tremendous long-term potential– they will anchor the new reserve currency. Sure, there is the inflation/hyper-inflation argument that will send gold sky-high (though I would suggest that there is ample evidence of deflation as well).

Predominantly, though, precious metals will rise as a function of capital inflows– foreign governments are sitting on trillions of US dollar reserves that they are trying to get rid of.  Gold is where they are going to park most of it.

Three months ago I wrote about some silver investments that I was making– I sold $10 December 2011 put options and bought $15 December 2011 call options. In each of these investments I was betting that the future value of silver would rise.

In 3-months these investments have more than doubled, and I am now analyzing the futures markets to find the best ways to invest directly in gold and silver.

In part, this is what I am doing back in Shanghai.  My longtime friend and colleague Christine Verone is the first foreigner ever to be certified by a Chinese exchange, and I plan on taking new gold and silver positions based on her insight of the Asian markets.

More on this in future letters. In the meantime, look after your savings if you’re dollar-based.  If your savings is sitting in the bank collecting dust, either get it out of the dollar, or put it to work generating a real return.

It’s not time to be on the sidelines anymore.

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