Oil Spikes Up in Global Confidence

When you have been in this business as long as I have, certain patterns become apparent; and one of those patterns showed back up yesterday. In the 20+ years that I have been working with Chuck, it always seemed the currencies rally whenever Chuck spends a week or two away from the desk. We call it ‘Chuck’s vacation rally.’ Yesterday we saw the dollar drop and the currencies bounce back up beginning what looks like another leg in the long-term trend.

The biggest gainer in the currency market yesterday was the Norwegian krone (NOK), which shot up nearly 2% versus the US dollar. The krone got help from oil prices, which rose for a third day in a row and moved through $81 for the first time since May. Signs that the global economic recovery is progressing have increased demand expectations, while the upcoming hurricane season and increasing tensions with Iran have traders worried about supply. The Energy Department will release their crude oil supply report later today; but a Bloomberg survey indicates that oil supplies fell by 1.5 million barrels last week.

Higher oil prices will benefit Norway’s economy, adding to their already strong economic fundamentals. The Norwegian krone continues to be one of my favorite currencies, with very strong underlying fundamentals and increasing demand for their commodity exports.

Another country which benefits from higher oil prices is the UK; and the pound sterling (GBP) increased 1.26% versus the US dollar over the past 24 hours. The increase put the pound at the highest level versus the dollar in almost six months. A report showed UK manufacturing expanded in July a bit faster than most expected. Another factor that boosted the pound was the announcement that the government-owned lender Northern Rock Asset Management Plc turned its first profit, boosting confidence in the UK recovery.

Technical analysts at Commerzbank predicted that the pound could reach $1.597 if it breaches a key technical level. The strong move overnight saw the pound push above $1.59, and it certainly seems to be well on its way to test the $1.60 figure.

But long-term I am still bearish on the pound sterling. The reason is all of the quantitative easing that the UK has used, and the tremendous amount of liquidity this has unleashed into the markets. While inflation has remained in check for now, I just don’t believe the Bank of England will be able to successfully drain all of this liquidity from the markets when the time comes. I think we are in for a volatile time in the UK, and the US is probably right behind.

But a lot of very smart people are actually calling for additional QE programs here in the US. Our own St. Louis Fed President James Bullard was all over the news wires the last few days after suggesting the FOMC should be doing much more to stimulate the economy. Mr. Bullard had been considered a centrist, and was traditionally one who kept a keen eye on the inflationary threat. But his recent comments clearly put him over into the camp of San Francisco Fed President Janet Yellen who continues to call for additional QE spending. This makes the August FOMC meeting a bit more interesting, as there are real possibilities that the Fed will tilt their words toward the risk of deflation, and away from their more traditional tough talk on inflation.

Ben Bernanke was in the news again yesterday, after taking a backseat to his predecessor over the weekend. The current Fed Chairman sounded a bit more upbeat on the economic prospects than Big Al Greenspan. Bernanke is convinced rising wages will probably spur household spending in the next few quarters. I think Bernanke may be holding his employment graph upside down! From my view in the cheap seats, employment isn’t picking up here in the US, and looks to be a continued drag on the economy. With an expected period of high unemployment, I just don’t see where Bernanke is seeing the possibility of rising wages.

As I said earlier, there is obviously a split among members of the FOMC, with some suggesting the US economy is spiraling into a deflationary spiral while Bernanke is saying he expects rising wages and more consumer spending. The divide will most likely keep the FOMC from making any kind of move, and rates will stay where they are for an extended period; waiting for additional signs the US economy is moving one way or the other.

The RBA kept rates on hold for a third month after slower inflation and a recovery in Asia made it prudent to just keep rates where they are. The non-move was expected by all of the economists surveyed, so it really didn’t have much of an impact on the Aussie dollar (AUD). The RBA is still leaning toward higher rates, and we expect another couple of increases before year-end, which should give the Aussie dollar another push up toward parity with the US dollar.

The New Zealand dollar (NZD) – or “kiwi” as it is know in the currency markets – has had a nice run up in the past month, as investors have moved back into the higher yielding currencies. The kiwi held steady above 0.73 yesterday and seems to be forming a nice base for another move higher. With the global recovery well established in Asia (the biggest export market for New Zealand dollars) the kiwi is well positioned and could be an attractive alternative to the lower yields found in Europe.

And gold held fairly stable yesterday, while silver had a nice run higher. As usual, the press has been focused on Gold as the precious metal of choice, but silver has been making a nice run higher recently. Silver has moved nearly 3% higher during the month of July, while gold has sold off by just over 2%. On a year-to-date basis, silver is up over 9% while gold is about 1% behind with an 8% appreciation. We always encourage investors to keep a well-diversified portfolio, and that goes for your precious metals holdings as well as currencies. Many investors shy away from silver because of the costs involved in holding it, but our unallocated accounts are a perfect way for you to hold silver at minimal costs.

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To recap: Oil surged to a 3-month high and pulled the NOK and GBP with it. Bernanke is confident in the ability of the US consumer to spend our way out of trouble. The RBA keeps rates unchanged, but leans toward further tightening, and silver has outshone gold recently.

Chris Gaffney
for The Daily Reckoning