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ECONOMIC JITTERS DRIVE GOLD, YEN
Prepared by Great Pacific Trading Company
(September 2006) The news from August brought more of the same on the macroeconomic front, more signs of a soft housing market amidst subdued inflation and (still) high commodity prices. Interest rates fell as expected, while the bond market and The Federal Reserve ponder the same questions as to whether we are headed for a resumption of the inflationary spiral witnessed in the first half of 2006, or bound for a recession in the first half of 2007 as portended by the inverted yield curve and eroding home sales.
Two seemingly uncorrelated markets could both stand to gain from the current uncertainty, both gold and the Japanese Yen stand to be affected by the standoff between the inflation hawks and the doomsday crowd awaiting the bubbles to burst.
Gold is, of course, a longstanding hedge against uncertainty, and there is no shortage of uncertainty in the current investment climate. This market has been in a strong up-trend for several years now, fueled in part by the prospects of war, but also the 'cheap money' stance adopted by The Federal Reserve over the same span of time.
The implication at the moment is probably bullish for gold whichever way it plays out. Either the Fed determines inflation is a problem, based on fresh evidence as it develops, and is forced to act to offset it. Inflation is equal to a decline in the purchasing power of the dollar. A decline in the dollar's purchasing power will usually translate into a higher price of gold, and everything else.
On the other hand, data may continue to overshadow the hazards of inflation with the need to stimulate the economy through lower interest rates. By lowering interest rates, the Fed encourages borrowing and pumps up the money supply. The dollar is likely to fall against other currencies if this occurs, which should boost the price of gold--a currency in its own rite, interchangeable for any paper currency in the world.
The one notable exception could be the Japanese Yen, which may in fact fall faster than the dollar if rates begin falling again. Because the recent (and not awe inspiring) strength in the yen was predicated on the Bank of Japan raising interest rates from historic lows, the possibility of them doing so for a sustained period is nil if the Federal Reserve is having to cut rates to fend off deflation.
As yields fall in the U.S., yields will probably fall again in Japan as well, encouraging even more borrowing from that country and diluting the value of the yen against all of Japan's trading partners.
If rates continue higher, the yen may yet rally from the present lows. However, internal weakness in the market has led to currency markets trading the yen down to a major support zone, which does not appear to be sustainable over the intermediate term.
GOLD TRADE--Buy December gold on a break above 640, risking a $15.00 trailing stop. Also buy December 680/700 gold call spreads for $300 or better.
YEN TRADE--Sell December Japanese Yen futures on a break below 8600, risking 150 point trailing stop.
September 14, 2006
Great Pacific Trading Company
1235 N.E, Sixth Street, Grants Pass, Oregon
P.O. Box 520526
Independence MO 64052-0526
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