Cage Fight Tonight: USD/EUR v. Au/Ag, Round 1!

Ding, ding, ding! Round 1 in the latest USD/EUR versus Au/Ag (that's Gold/Silver) is underway! Its Fiat Money versus Hard Money, Paper versus Physical, Fantasy World versus Real World...and it is on, baby! Bookies on the back row!

Gold and Silver are, of course, looking nice and shiny tonight: though over 100 years old now, that 1912 St Gaudens is $2o Piece is just as austere a fighter as ever. Look at that footwork! And likewise, that tiny little 1964 Roosevelt dime will not only still buy you a gallon of gas, but he's looking pretty trim in that silk hoodie! Silver, of course, is still recovering from that black-eye suffered during last Friday's COMEX beat-down (apparently its hard for even cage-fighters to battle while handcuffed), and Gold has a sprained ankle after a noticeable slip that same day. And across the cage, EUR and USD are looking....well, hold on....

EUR and USD are...they are looking....let's see....wait a second, I don't see them....standby for second here...

Where are USD and EUR? Hey, has anyone seen EUR and USD? Oh wait, no, of course no one has seen them, I almost forgot---THEY DON'T EXIST!

Some cage-fight this is going to be: Gold and Silver are standing there in hooded silk robes, and EUR and USD don't even exist. This totally sucks!

Alright, now let's get down to business. What is going on with the fiat-paper watching USDX and real-world commodities?

There's a saying that "Dr Copper is the only commodity with a PhD in economics." Goldbugs dispute this, but the idea is that moves in spot copper prices are leading indicators for the overall macroeconomic outlook, particularly in reference to an economy heading into or out of a recession. You might remember that copper was over $4/lb back in that hectic "Commodities Summer" of 2008, when platinum was over $2,000/oz (and up to $2,200/oz) and oil was $148/barrel. Within months and before the end of 2008, platinum was under $800/oz and oil was under $30/barrel. Just before the downward moves in these commodities (PM's and energy), copper was coming off its summer high, and coming off in the hurry: copper went from over $4/lb to under $1.50/lb before finally starting back up with everything else in March 2009.

Copper returned to and smashed through the '08 high in November 2010, and spent most of this year above $4/lb, and even above $4.50/lb, setting record high after record high....until a couple of weeks ago. This week copper slid under $3/lb briefly, and like silver, is off 25% since the beginning of September. Ouch.

Personally, I'm skeptical of Dr Copper's recession-predicting abilities: I think of the commodities markets more like proxies for domestic and international bank trading desk activity and profit-seeking than as indicators for recession. But that said, bank activity in the commodities markets is so intense and so large scale that decision by banks to pull back here or there will absolutely manifest much more dramatically in the commodities markets than in bonds and equities, where their presence is likewise certainly massive, but less so by percentage. Also, the individual commodities markets are quite small compared to Treasuries, bonds, or stocks, and included few investor classes and fewer investors, period.

To put it in perspective, Apple (AAPL) daily volume averages around 24 million shares exchanged. With the current price at $380 or so, that's a daily priced-volume of $9.12 Billion. Now, how many people do you know who own Apple shares? How many funds? How many private equity groups?

Or let me put it this way---do you know any of these classes of investors who don't own Apple shares? Do you know of any pension funds that don't own AAPL today? "Everybody owns Apple!" (Disclosure: not me--I own no stocks)

Now, let's look at my personal favorite bi-polar money/commodity--silver! I say that silver is bi-polar ever so lovingly, because silver is a money metal controlled by commodities traders. Gold, I think, has broken free of the "commodity" label that it should have never had, and perhaps silver will one day as well (after all, it was so for thousands of years, and all the way up to 1964 in this country). For now, silver is considered by most a "commodity."

According to the LBMA (and believe them or not, its up to you), silver is averaging about $6.07 Billion daily priced-volume, or 2/3 of what AAPL does in a day. So--how many people do you know who own silver? How many pension funds own silver (hint: none! its against their charters to be in "commodities futures")? How many private equity funds are heavy on the white metal? And again, how many people do you know with any silver at all--even silverware?

Any one?

You're lucky if you have friends who own silver, because you've found a friend of a very small minority, as most people simply don't, most institutions simply don't, and honestly most people think you're at least a little "strange" if you do own anything like silver---or, heaven forbid, gold("OMG! That's so barbaric!"). The massive players in this much smaller-than-Apple-shares silver market are---guess who?

Yes....the banks.

And I'm not just talking about the concentrated shorts, but the "buyers" are banks as well. And it is not just silver, but all other commodities (in fact, corn might be the most banksterified commodity lately). When you consider that the 30-yr is yielding under 3% right now, it cannot be surprising. How does a bank lend money for 30 years at a negative real rate and make money? Hint: you can't make money when you're lending at a negative real rate: and it is a negative real rate, because even according to the Federal Reserve, 30-yr inflation expectations are over 3%. Banks are chasing whatever they can, and commodities offer big returns, even if it is with big risk. I would argue (and do here) that it is the same risk banks are taking in buying up Treasuries at record high prices---but at least commodities don't have a pre-set par value; since commodities are prices in USD, they can theoretically go up in price to no limit. Banks that trade on trends (which would be most banks) aren't stupid, and they see what commodities offer these days, and they get in. Furthermore, its a dollar hedge for anyone sitting on all that USD: USD up, commodities down; USD down, commodities up (or at least they assume).

Hence my skepticism of Dr Copper: I don't even think the commodities markets are real indicators of commodities use (unfortunately). If the US required delivery, this would obviously change, because then banksters (who have never even seen a physical contract of copper, let alone the inside of a Freeport McMoran facility or anything else real about the commodities they "buy") would flee from commodities like the plague---or at least like they did before the 1999 regulation changes, and before Helicopter Ben's money drops. So, if banks are the big players in the commodities markets, to whom should we look first when we see massive commodities sell-offs like we have for the past two weeks?

I'm looking at the banks. But why are the banks selling off positions in commodities?

A.) Because they need capital to cover for losses elsewhere...like in the Euro bonds market.

B.) Because they are bidding up on margin chasing any gains they can get in this ZIRP world, and the Exchanges are hiking margin requirements because of A and C.

C.) Because the European financial meltdown is clearly demonstrating that counterparty risk never really was "fixed" nor "solved" nor in any way made to "go away," and using counter-party "backed" OPM to bet on something as volatile as commodities is suddenly not seemingly like such a good idea.

D.) A, B, C

D.) all of the above.

Let's go to hard money and commodities for the answers/proof, per usual. The biggest story this month for the hard money crowd is the routing of commodities last week, especially silver and gold. Silver took a major hit last Friday (Sept 23) in particular, getting slammed 30%. That's hard to watch even after surviving the beat-down offered the first week of this May (also painful). The usual suspects started with the "bubble"-speak, and Infowars featured a rather financially imaginative reporter who was utterly perplexed at why people would ever even doubt the dollar, when gold is "back by nothing" and the dollar---you remember, that invisible thing that didn't even show up for the cage-fight--is "backed by the government."

Oh, brother.

Indeed, if you were a clueless reporter, or very financially adept infant who happened to have been that born this past Monday last, September 19, you surely would have immediately started watching Bloomberg Surviellence Midday right away, in lieu of Sponge Bob. By Friday the 23rd, you very well might have been convinced in your cute little less-than-one-week-old mind that given

1.) the week's smashing of commodities,

2.) the week's rally in Treasuries, and

3.) the week's move in USD,

perhaps the dollar is the investment of your lifetime!

And, and like many one-week-old babies who offer financial advice, you would have been just a little premature in your analysis, though strikingly consistent with what nearly every "financial analyst" on MSNBC would themselves suggest. "Buy dollars! They're backed by the government! The US can't default---we have printing presses!"

For those of us who aren't one-week old, let's put the last two weeks in perspective. Nevermind the proper perspective, which reaches back to 1971 for gold and 1964 for silver, when gold was $35/oz and silver was $1.25/oz; no, we'll surely be chastised that "oh, but it was different back then," so we can't possibly do that! So, we'll acquiesce, and just go back 12 months for a little perspective. Was it that different 12 months ago? Hmmm....

You might not remember it, but here is what was happening 12 months ago, and what's happening today:

Silver spot per oz, October 1, 2010: $21.98.

Silver spot per oz, October 1, 2011: $29.98.

Gold spot per oz, October 1, 2010: $1315.

Gold spot per oz, October 1, 2011: $1620.

In other words, silver is up $8.00/oz, or 36.4% since this time last year. Gold is up $305/oz, or 23.2% since this time last year. Now, since the economy is just stellar and everything is great and has been totally repaired (what, you didn't notice?) over these past 12 months, how about USDX?

USDX, October 1, 2010: 78.47

USDX, October 1, 2011: 78.55

Or, courtesy a Bloomberg USDX screen-shot:

And what you're looking at is pretty important.

Now, let's blend this information. USDX is almost exactly were it was 12 months ago, with a negligible 1/1o of 1% change (and please note USDX can swing 10 times that intraday!). If USDX is accurately reflecting the dollar's ability to trade for hard money, then the gold and silver prices in USD should be just 1/10 of 1% higher today than they were 1 year ago.

But, wait---we have the data above: gold is 23.2% higher and silver is 36.4% higher. What is going on here?

That USDX chart is like a roller-coaster: a lot of up and down, but you end up where you start. If commodities (or anything else) were tethered to the USD, then they too should be just about where they were at this USDX level. But they aren't. Now, let's look at equities:

DJIA, October 2010: 10,944

DJIA, October 2011: 10,913

S&P 500, October 2010: 1146

S&P 500, October 2011: 1136

According to USDX, the DJIA, and the S&P500, its almost as if this last year hasn't even happened! This is almost like market time travel! And what's more, you can see that the price changes in equities are following (tethered to?) the USDX while the price changes in gold and silver are not. Commodities and the USDX are supposed to weight opposite sides of the see-saw: one goes up, the other goes down. But now we have 12 months of data that shows when one goes up (USDX), the other isn't coming back down all the way. The direct 1:1 inverse relationship is breaking down, and it is breaking down against the USDX, and against USD.

Let's look at the USDX more closely. USDX is a composite index that values USD's purchasing power against the six other major currencies. Also, it is weighted, and weighted heaviest to euro. Here are the pieces of the USDX pie:

Euro (EUR): 58.6%
Japanese Yen (JPY): 12.6%
Pound sterling (GBP): 11.9%
Canadian dollar (CAD): 9.1%
Swedish krona (SEK): 4.2%
Swiss franc (CHF): 3.6%

Graphically, this pie looks like so:

Its a good thing for USD that CHF (aka Swissie) is weight at just 3.6%, because Swissie has been on a tear this year, breaking all kinds of records and raising to the highest USD price ever. The real weight in USDX, as you can see, is EUR, and unlike Swissie, EUR wasn't been doing to well at all this year. Yes, apparently the whole "oh my goodness, the entire EU is going broke without Germany" thing isn't too good for one's currency. When USD gains purchasing power on EUR, the USDX increases numerically, which leads to a decrease in USD commodities prices. Conversely, when EUR gains on USD, EUR gets more costly, USD losses value, and commodities priced in USD cost more USD, so the price goes up. Check out this 1-yr USD-EUR chart in combination with the 1-yr silver directly below it:

They are quite similar, as the peaks in EUR value are reflected in price (the $1.48 early May EUR high) on the USD-EUR part, and these correspond to USD weakness, which, again, is reflected in commodities as a higher price. But what's not similar are the ends of either: EUR-USD is nearly unchanged over the year (despite the roller coaster in the middle), from $1.33 last year to $1.36 this year, but silver--again--is up over 36%. That is quite a difference! This doesn't seem to fit the "dollar up, commodities down" in that 1:1 inverse relationship everyone has assumed for quite some time. For silver at least, that 1:1 has eroded to 1:0.64 or so.

I could very well be totally premature on this: perhaps next week USDX will push back and smash commodities again. But USDX has had two weeks of nothing up good press, jittery commodities traders, and margin hikes in its favor, and it hasn't been able to clean up that 36% silver spread, nor the 23% gold spread. Surely we are in for yet another crazy week.

This feels like mid August 2008.