Zhou Talks About Diversifying Their Reserves

Good day…And a Happy Friday to one and all! Your Pfennig writer still is fighting the remainder of a head cold, and the “rainforest flu” – but I think I’m on top now, and beating the virus into submission! That’s a good thing, considering I’m heading to New Orleans next week!

Well…the trade deficit did “narrow” in September as I told you to expect it would, and the media was all over the story like a cheap suit. Good for them! The deficit did “narrow” more than what was forecast, and the dollar rallied on the news. However, before everyone gets out their pom poms and starts working on a cheer for the trade deficit, let me tell you that there were some large airplane sales involved.

The dollar was weaker in September – and then let me bring everyone back to earth by reminding them that this report was for September – and recall that just two days ago I told you that China had reported an outstanding trade surplus for October of $23.8 billion! You don’t think that most of that was done with Europe do you? No sirree Bob! Most of that was done with the United States.

So, we have to wait for the U.S. trade deficit in October. The suspense is killing me!

OK…all that, and then the big news story of the day – and maybe of the year, when it’s all said and done. Are you ready? Seat belt strapped in, snug and low across your lap?

The dollar fell on its face yesterday afternoon, allowing the currencies to take liberties with the greenback, after Reuters reported some comments by the People’s Bank of China’s Gov. Zhou. So…let’s go to the tape!


That sounds like brand new news doesn’t it? Well…traders took the bait and ran, driving the dollar down to levels it hadn’t seen in two months. But what Mr. Zhou said was really nothing new. Here were his actual statements:

“All central banks are trying to diversify,” he told Reuters on the sidelines of a European Central Bank conference in Frankfurt. “We have had a very clear diversification plan for several years.”

When asked whether China planned to shift its foreign exchange portfolio away from U.S. Treasuries and into higher-yielding U.S. corporate and mortgage-backed debt, as reported by a newspaper this week, he said: “We are considering lots of instruments (for diversification).”

The traders still didn’t care. So…as I’ve suspected for some time now…traders have been looking for any good reason to sell dollars, and this just happened to fall into that category. And I’m all for it, but you have to ask yourself these questions about the statements: What is the plan? When will it be implemented?

If you really think about the whole thing, the Chinese did exactly what they’ve done all along. They tell us something, but they don’t give us the details. Details, stinkin’ details!

So that’s about all there is to tell you about what happened in currencies yesterday. The dollar rallied early, and then got taken to the woodshed in the afternoon. In the overnight sessions the dollar has remained under pressure. So there’s something to all this, and like I said above…this could be the story of the year!

What we need to confirm though, is some strong follow through; and with the data cupboard emptied out for the week, I don’t know if we’ll get it. There is a Central Banker meeting in Frankfurt, where Zhou, Big Ben Bernanke, and ECB President Trichet are speaking. So you never know what kind of bombshell comes from that…if any.

Gold and silver also took liberties versus the dollar yesterday. At one time, gold was up over $17 on the day. Dollar weakness will show up here almost as fast as it shows up in a rising euro…and the continuing dollar weakness may not come today, next week or next month. But given the historical trends, the awful fundamentals in the United States and the growth in China…I believe continued dollar weakness will come. And then, I want all the jokers who keep telling us that “deficits don’t matter” to line up against the Great Wall of China (Cash) so they can be ridiculed!

Remember…the rise in gold has been fueled by many sources, including purchases from investors in China and India. If China were going to “diversify” its dollar reserves, I would expect a somewhat large investment in gold to be a part of that “diversification.”

The head of our Bond Desk, John Kaupisch, tells me that actual yield curves all around the world have inverted, some very slightly. I think that when the ECB raises rates next month, it will take care of that inversion… For now, the thought…when yield curves invert is to remain short with investment duration. That includes your foreign currency CD’s!

Currencies today: A$ .7682, kiwi .6660, C$ .8860, euro 1.2885, Sterling 1.9165, Swiss .8090, ISK 67.50, rand 7.2250, krone 6.3650, SEK 7.06, forint 202.55, zloty 2.9808, koruna 21.8865, yen 117.25, baht 36.60, sing 1.5560, HKD 7.7830, INR 44.71, China 7.8645, pesos 10.91, dollar index 84.89, Silver $13.03, and Gold… $632.80

That’s it for today…Tomorrow is Veteran’s Day, which always gets me a little misty eyed, as it reminds me of my dad, who was a WWII veteran. My darling daughter Dawn, got a picture of my dad in his uniform to show to her class as a part of their recognition of Veteran’s Day. If you’re not into sappy stuff, no reason to go on. Have a great Friday and weekend…

But for the rest…here’s what my darling daughter Dawn sent to me last night:


Today we had our annual Veteran’s Day Assembly. I submitted the picture of Grandpa Butler last year and it was used again for the power point slide show this year. This year when it came up on the screen…I realized just how much you look like Grandpa. I don’t think I ever noticed just how much you look like him before. It is such a handsome picture of him in his uniform, it brought tears to my eyes. Just thought I’d share!”

So…Hug a Veteran. They won’t always be around to thank for what they did.

Chuck Butler
November 10, 2006

The Daily Reckoning