Gravity Gets Its Man

The Daily Reckoning Weekend Edition
November 6-7, 2004
Baltimore, Maryland
By Addison Wiggin and Tom Dyson

Friday was the single most pivotal day in the markets this year, we commented to Addison via Instant Messenger.

Addison is in China… he had just woken up to a fine Saturday morning in Shanghai… while your Baltimore-based editor was still wrapping up his Friday afternoon at the Daily Reckoning HQ in Baltimore. Addison hadn’t seen the news…

He hadn’t seen gold had just moved to levels not witnessed for nearly 16 years.

He hadn’t heard that payrolls were hot, very hot. 337,000 new jobs were added in October, said the BLS, including an upward revision of 113,000 to the two previous months. Wall street put in its best weekly performance for nearly 19 months.

He didn’t know about the weird behavior in the currency markets either… the euro made a decisive move higher – high enough to make a new lifetime record: 1 euro now buys $1.2962 – yet it should have been falling, according to conventional wisdom.

We pondered why the dollar would fall on a day when short-term interest rates rose.

After all, it seems that two such ponderous masses as the dollar and its yield would move together. At least, that’s how it would seem to a couple of British men like Sir Isaac and your editor.

"Gravity," typed Addison. "The structural forces pushing the dollar lower are so powerful, that one strong payroll report doesn’t make any difference."

By pushing the short end of the yield curve higher, Eurodollar traders are signaling they expect the Fed to raise rates at both the next two FOMC meetings, which should make dollar deposits more attractive.

So far this year, the dollar has been incredibly sensitive to changes in short-term interest rates, as it should be. When inflation expectations rise, so do interest rates, and the dollar rises in sympathy. Not on Friday, the dollar diverged from its yield.

Addison chalks up this strange behavior as just another piece of evidence that the dollar’s bear market is alive and kicking.

Despite the dollar’s swoon, Wall Street’s rampant optimism was palpable. A reborn president, 300k+ new jobs, oil pulling back below $50 to $49.61 and stock indices surged higher. The Dow gained 360 points on the week, a 3.5% surge, to 10,388. The Nasdaq was up over 3% to 2,039 as was the S&P… it pushed 36 points higher to close at 1,166.

Bonds got crushed. 10-year Treasury yields climbed 16 basis points last week, and are now selling for 4.19%. The long-end moved higher as well with 30-year government bonds gaining 15 basis points on the week. Over the last few years, bond yields have moved in virtual lockstep with the dollar. "This is not, however, a situation we expect will continue for much longer," argues the Speculative Investor. "If the dollar keeps falling then it is bound to cause inflation expectations to rise. On the other hand, if the dollar starts to rise then the inter-market relationships that have dominated the financial markets over the past few years should ensure that bonds take a hit. In other words, regardless of what happens to the dollar we don’t see much scope for bonds to advance from their current elevated level."

That the fundamentals are finally exerting their downward pressure on the dollar despite other existing medium-term inter-market relationships is great news for anyone holding that strange yellow metal we shamelessly promote here at the Daily Reckoning.

The conditions for a stunning bull market in gold have been in place for nearly a decade. Now the toil is starting to produce fruit, and the markets are beginning to notice…

On Friday, gold made a new 16-year high at $433.40 an ounce.

Gravity always gets its man, and when it does, $500-gold will seem unbearably cheap.

Tom Dyson,
The Daily Reckoning
November 6, 2004

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