British Pound Sterling Losses "Safe-Haven" Status

Good day. Another busy day on the desk yesterday, as the increased volatility in the currency markets had the phones ringing. Many of the clients calling the desk were worried about the recent drop in the currencies and metals. Some want to bail out, while others are seeing the fall in prices as a good buying opportunity.

We continue to remind callers that diversification is the key to long-term investing success, and the best strategy is to make an investment plan and stick with it. But before I get in trouble with the lawyers, I better get back to the purpose of this letter, which is to give readers a recap of what is going on in the currency markets.

The Greek crisis jumped back onto all of the trading screens last night after the Greeks finally admitted they couldn’t form a coalition government, and planned another election in June. The problem with these new elections is that there is a high risk that leftists opposed to the terms of an EU bailout will sweep to victory in this next election and send the eurozone into a deeper crisis.

Both of the parties who won the largest percentage of the last vote want to remain in the euro (EUR), but promised to “renegotiate” the terms of the bailout agreement. The second round of elections could shift the results further left, making the withdrawal of Greece from the euro a higher probability.

In addition to the Greek crisis, yields on both Spanish and Italian bonds rose yesterday as investors sold and sought safer havens. Moody’s Investors Service downgraded 26 Italian bank ratings, citing Italy’s recession and increasing bad debt. It also warned that Spanish banks face additional challenges.

And there is probably more bad news to come from the rating agency, as a Moody’s official said the rating agency is postponing possible downgrades on more than 100 banks worldwide as it assesses the fallout from JPMorgan Chase’s trading losses.

None of this was good for the euro, and the single currency unit approached the 12-month low of 1.2624, which it reached on Jan. 13. Bad news for the euro corresponded to an up day for the U.S. dollar, which is seen as the only “safe haven” in the most-recent crisis. The U.K. economy fell into a second recession, while Europe has avoided the double dip, according to official numbers released yesterday.

The pound sterling (GBP) was seen as a safe haven from the euro crisis, but the pound weakened the most in a month versus the U.S. dollar after the BOE said the U.K. economic growth was likely to remain “subdued” in the near term.

Central bank Governor Mervyn King admitted the U.K. faced threats from the euro crisis as he released the quarterly report on inflation. “Concerns about the possibility of a disorderly resolution” in the euro area have “adversely influenced asset prices, bank-funding costs and confidence,” the BOE said in the report. “The MPC [Monetary Policy Committee] judges it likely that the possibility of such extreme outcomes crystallizing will continue to weigh on U.K. activity for some time, even if these outcomes do not actually occur.”

Shifting to the U.S., markets will be eagerly awaiting the release of the minutes from the last FOMC meeting, scheduled to be released early this afternoon. Chairman Bernanke said after the most-recent meeting that he is prepared to “do more” to boost economic recovery, which the markets took to mean another round of quantitative easing.

Investors will be analyzing the minutes of the last meeting to try and get a sense of whether or not QE3 is in our future. If there is any indication that another round of easing is in the offering, the equity markets will run higher and the dollar will get sold.

But before we get the minutes this afternoon, we will also get a boatload of other data releases here in the U.S. Housing starts are expected at 685,000, a slight increase from last month’s 654,000, and the month-over-month increase is expected to be a much-better 4.7% increase, compared with last month’s dismal 5.8% fall.

We will also get a report on building permits, which is a more “forward looking” report. Permits are expected to have fallen in April, down 4.5% from March levels. We will also see industrial production and capacity utilization, both of which are expected to show a slight increase during April.

Yesterday was chock-full of data with the release of the CPI and retail sales data. The inflation data showed consumer prices here in the U.S. rose at an annual rate of 2.3% in April, just as a majority of economists had predicted. Readers know neither Chuck nor I put much faith in this “official measure” of prices, and would rather look at John William’s ShadowStats, which pegs the price increases to a more-realistic 10%.

The retail sales numbers weren’t as encouraging, as sales slowed to a 0.1% increase during April, down from a 0.8% gain in March. Other data showed the New York state manufacturing activity improved, mostly due to falling energy prices, and business inventories were up a bit, at a 0.3% increase.

One of the most-important pieces of data released yesterday didn’t get any press in the mainstream media (no surprise there). Data showed the total net TIC flows dropped $49.9 billion in March, but the newsies chose to focus on China’s increase in its holdings of U.S. Treasuries in March. Our friends over at The 5 Min. Forecast had some interesting things to say about the increase:

“Yes, China beefed up its holdings of U.S. Treasuries in March, according to figures out this morning from the Treasury Department. But if you widen the scope and go back six years, a couple of interesting things happen. First, the increase in March was so small as to barely show up on the chart…

“And second… China’s holdings peaked last July. Coincidentally, that was the last month before Uncle Sam lost its AAA rating. The numbers declined markedly through the end of 2011, and stabilized in the first three months of 2012. This is especially interesting when you consider how Chinese imports of gold grew at the same time Chinese purchases of Treasuries were shrinking.”

They point out that China is slowly accumulating gold, but you wouldn’t know that by the recent price movements. The shiny metal dropped again yesterday, to a new low for 2012, at $1,526.97. It has bounced back up from its lows, but is still trading in the $1,540 range.

I pointed out my thoughts that gold is an excellent place for investors seeking a safe haven, but the recent trading patterns show that most investors feel it is more of a “risk” asset. The correlation between gold and the dollar has been moving closer to –1, which would indicate a perfectly negative correlation (a negative correlation indicates gold moves down as the dollar moves higher). The 30-week correlation coefficient between the greenback and bullion is now at -0.66, compared with -0.24 in September.

But some of the biggest investors feel gold will rebound from its current levels. Bloomberg reports that the median estimate of 11 analysts who track gold indicates the price will average $1,740 in 2012. Goldman Sachs’ commodity research team believes the Fed will start a third round of QE in June, which will push the value of gold higher.

Billionaire George Soros raised his stake in gold, according to a filing yesterday reflecting first-quarter holdings. Central banks are buying bullion at the fastest pace in five decades, adding 439.7 tons in 2011, and they will probably purchase a similar amount this year, according to the World Gold Council. Sounds like a good opportunity to increase metals holdings at good prices!

Chuck is working out in Las Vegas this week, giving a couple of talks to packed rooms as usual. I miss attending these shows with Chuck, who is treated a lot like a rock star at them. Fans constantly drop by the booth to shake his hand and pick his brain on the markets. He sent me the following reflections from the floor of the Las Vegas MoneyShow:

“Most people here at the Las Vegas MoneyShow believe, as I do, that the back side of the storm is about to hit the U.S. But then again, 250 of them were Pfennig readers in this humongous room I was in yesterday!

“I said something to the people there when talking about the Pfennig, and it hit me like a brick! I’ve been writing the Pfennig in one shape or form for 20 years now! WOW! Who would have thought that those handwritten notes to salesmen each morning would turn into this 20 years later!

“Even when I was ‘retired,’ after Mercantile performed ethnic cleansing on Mark Twain employees, I wrote the Pfennig from home. Back then, Alex was only 3, and used to sit on my lap and pound away on the keyboard so that portions of the Pfennig looked like this: : )*%PLKE#&^)*!

“Alex is almost 17 now — amazing how time flies, eh? But the point here is that longtime readers that go back to Mark Twain Bank days have been with me through a lot. I’m thankful for your loyalty.”

Chris again. Yes, I remember back 20 years ago, when I would find a handwritten note from Chuck on my desk when I arrived each morning. Back then, we didn’t have the Internet, so he would jot down his thoughts and leave copies on everyone’s desk. We started passing these notes along to the investors we were talking to via fax, and eventually Chuck switched to passing it out electronically.

Then there was this. I haven’t commented on JPMorgan Chase’s $2 billion trading loss, which really put egg on the face of Jamie Dimon, the outspoken CEO of the company. Dimon was one of the loudest voices protesting the additional banking regulations working their way through Washington.

Yesterday, I read a story that I immediately thought would be a great story for this morning’s “Then there was this.” The story, which appeared on Bloomberg and was also picked up by our local paper, was titled “Fed Conflict Raised for JPMorgan.” The article points out that Dimon is one of three bankers sitting on the board of the New York Fed, as required by law.

That’s right, the Federal Reserve Act of 1913 actually mandated that three of the nine seats on the regional reserve bank board be occupied by bankers. The article quotes Sen. Bernard Sanders, who sees an obvious conflict in Dimon’s two roles. “It is an obvious conflict of interest for Jamie Dimon, the CEO of the largest bank in America, to serve on the New York Fed’s board of directors,” Sanders said in an emailed statement. “This is a clear example of the fox guarding the henhouse.”

To recap. Greeks will be returning to the polls in June, and the currency markets are worried about the outcome. The euro dropped again, both on the new Greek elections and a cut to Italian bank ratings by Moody’s. The pound sterling dropped, and may not be the “safe haven” that some investors thought. We got a boatload of data released yesterday, and will get even more out this morning. Most of the data showed the U.S. economy continues to “muddle through.” China is continuing to increase its gold holdings, along with some very influential investors. And I ended today’s Pfennig with a note from Chuck, who is speaking to the masses out in Las Vegas.

Chris Gaffney
for The Daily Reckoning