Risk Factors
The Rude Awakening
Wall Street, New York
Tuesday, February 1, 2005 ------------------------- The Rude Awakening PRESENTS: Why do tax and regulation
avoiders, drug dealers, merchants of death, entrepreneurs
and mafia all prefer euros to dollars? Clue: It has nothing
to do with exchange rates… ------------------------- RISK FACTORS
By Eric J. Fry "You should consider carefully the risks described below
before making an investment decision," advises the
prospectus of the streetTRACKS Gold Shares (NYSE: GLD).
"Fluctuations in the price of gold could materially
adversely affect an investment in the Shares." We had a hunch, even before reading the prospectus, that a
falling gold price might be a bad thing for GLD - an
exchange-traded fund "designed to mirror as closely as
possible the performance of the price of gold bullion." But we also had a hunch that a falling dollar might
be a good thing for GLD. Reading the prospectus confirmed
both hunches. By definition, a buyer of dollars is a non-buyer of gold.
Any examination of gold's "risk factors" would not be
complete, therefore, without also considering the risk of
NOT owning gold - also known as the risk of owning dollars. "The price of gold has fluctuated widely over the past
several years," begins the "Risk Factors" section of the
prospectus. "Several factors may affect the price of gold,
including: Global gold supply and demand, which is influenced by
such factors as forward selling by gold producers,
purchases made my gold producers to unwind gold hedge
positions, central bank purchases and sales, and
production and cost levels in major gold-producing
countries such as South Africa, the United States and
Australia Investors' expectations with respect to the rate of
inflation Currency exchange rates Interest rates Investment and trading activities of hedge funds and
commodity funds and Global or regional political, economic or financial
events and situations…
To be sure, all of the influences cited above affect the
gold price. But don't these same influences also affect
U.S. dollar, only in reverse? Or to rephrase the question,
which monetary asset is more likely to be "materially
adversely" affected by the risk factors enumerated above?
Gold, or the dollar? Falling inflation, for example, is the sort of monetary
trend that a gold bull would call a "risk factor." But
rising inflation, which happens to be the monetary trend of
the moment, is a clear and present danger to holders of
U.S. dollars. Notwithstanding official assurances to the
contrary, a new inflationary trend seems to have sprouted
from the seeds of Alan Greenspan's overly "accommodative"
monetary policies. The Consumer Price Index has been
trending higher for a couple of years, while many other
price gauges are soaring. The Intermediate Goods Index, for
example, has rocketed 9% over the last 12 months, as rising
energy and input costs have made their way into the
production chain. 
"Investors should be aware," the GLD prospectus continues,
"that there is no assurance that gold will maintain its
long-term value in terms of purchasing power in the
future." Again, we would respond: What about the dollar?
What assurance do we dollar-holders possess that the
greenback "will maintain its long-term value in terms of
purchasing power?" Apparently, some of the world's largest dollar holders are
beginning to have their doubts. "More than two-thirds of
the world's central banks have boosted the euro holdings in
their currency reserves over the past two years, largely at
the dollar's expense," the Wall Street Journal reports,
citing a survey by publishing firm, Central Banking
Publications. Meanwhile, a separate Journal story notes, "OPEC's dollar-
denominated bank deposits fell to 61.5% of total deposits
in the second quarter of 2004, down from 75% in the third
quarter of 2001, while over the same period, euro-
denominated deposits rose to 20% from 12%. Part, but not
all, of this reflect depreciation of the dollar." A few central banks are also adding to their gold reserves,
even as they reduce their dollar reserves. Perhaps these
gold-buying bankers have perused page 28 of the GLD
prospectus, which lays out "The Case for Investing in
Gold." "All forms of investment carry some degree of risk," the
bullish discussion cautiously begins. "However, including
gold in a well-balanced portfolio can help diversify risk.
Gold's ability to serve as a portfolio diversifier is due
to its historically low-to-negative correlation with stocks
and bonds." In other words, the ancient monetary metal tends to perform
well when faith in paper assets wanes. That's because, as
the prospectus points out, "Gold does not depend on a
promise to pay on the part of any government or
corporation, as is the case with investments in money
market instruments as well as in the corporate and
government bond markets. Gold is not directly affected by
the economic policies of any individual country and cannot
be repudiated, as is the case with paper assets. Gold is
not subject to the risk of default or bankruptcy. Gold
cannot be created at will as can paper-backed assets." All true…but the strongest aspect of the bull case for
gold relies upon the fact that the "Risk Factors" for
owning the U.S. dollar are far more numerous, far more
serious and far more likely than those for owning gold. If
we were commissioned to write a prospectus for the U.S.
dollar, we might caution: "The dollar's value may react adversely to changing
investor perceptions resulting from: - The retirement of a deified bureaucrat who chairs the
Federal Reserve
- A rapid decline in the value of U.S. financial assets
and/or real estate assets
- A growing perception of American fiscal imprudence,
as evidenced by its growing current account deficit
and rising foreign debts
- A derivatives debacle that becomes a banking crisis
that becomes a currency crisis
- A rise in the inflation rate above that which the
Federal Reserve chairman deems constructive
- The failure of an economy powered by Starbucks lattes
and Destiny's Child CDs to continue attracting direct
foreign investment." Gold's $4 drop yesterday reminds us of the risks of owning
the yellow metal. On the other hand, the dollar's 40% drop
over the last three years reminds us of the risks of owning
the alternative. So far, no one has approached us to write a prospectus for
the U.S. dollar…not yet. [Ed. Note: Did you know gold coins give you leverage AND
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By Eric J. Fry The euro is making inroads against America's "highest-
margin export," Jim Grant observes in a recent issue of
Grant's Interest Rate Observer. "Treasury Secretary John
Snow, brand manager of the U.S. dollar, has a problem on
his hands. Large-denomination euro notes are making inroads
on the $100 bill…" Grant continues: "Most of the world's currency drama takes
place on computer screens, of course; $7.2 trillion changes
hands every business day. But the interbank market must
eventually reflect the preferences of the monetary end-
users. And, at the margin, more end-users appear to prefer
the euro. "With that said, the U.S. dollar remains - hands down - the
world's dominant folding money. Between 55% and 70% of the
$703 billion of the U.S. currency outstanding circulates
outside the 50 states, according to Federal Reserve
estimates… But, we believe, this is yesterday's news, or,
at least, yesterday's trend. The greenback has some
competition. Coincidentally - or not - the dollar bear market began
about the time the physical euro first appeared on the
monetary scene. Though the euro appeared on computer
screens in 1999, it did not take the form of coins and
banknotes until January 2002. At that time, one euro cost
about 95 U.S. cents. The dollar bear market commenced
almost immediately, and continues to this day. (At last
check, one euro costs $1.30). Grant suspects that one
factor contributing to the dollar's slide is the "growing
popularity of the 200- and 500-euro notes… Participants
in the global cash economy - tax and regulation avoiders,
drug dealers and merchants of death, entrepreneurs and
oligarchs - are just beginning to discover them." "Much can be said against the euro and the political
coalition that manages it," says Grant. "Yet there is this
to be sad on its behalf: you can fit a lot of them into a
suitcase, or stomach… "In 2002, the ECB produced not one ?200 or ?500 note. It
struck off a run of ?200s in 2003 and a run of ?500s in
2004. Next year, says the bank, it means to expand the size
of the ?500, printing 190 million notes worth ?95 billion. "By value, the 2005-vintage ?500s would constitute half of
the year's currency production. As it is, the ?200s and
?500s together make up only 36% of euros in circulation. By
comparison, the $100 bill makes up about 70% of all dollars
in circulation. "A Treasury Department spokesman said that the U.S.
government has no plans to re-institute $500, $1000, $5,000
or $10,000 notes, denominations last printed in 1945 and
last issued in 1969. Perhaps, to enhance the dollar's
appeal, the U.S. government will resume printing big
bills… but for now, no dice. "The dollar bear market rolls on." [Ed. Note: Dr. Richebächer would enjoy this idiosyncracy.
He has studied the financial markets for nearly 60 years.
He digs deep into economic statistics and numbers, making
sense of arcane statistics in a way few can match. The
dollar is of particular interest to the Doctor. Here's a
summary of his recent conclusions: The Dollar Identity
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