Loose Monetary Policy and Commodity Based Currencies

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The International Monetary Fund, quite simply, is an organization that looks to secure economic and financial stability between its member countries; exchange rate stability is helpful in achieving this. Ultra-easy monetary policies, however, can create instability. Actions from central banks such as quantitative easing that we see in the US, Japan, and Great Britain create worries elsewhere in the world as developing economies particularly (the BRIC’s) see their respective currencies appreciate in foreign exchange markets. Furthermore, their foreign exchange reserves risk losing value as the status of a depreciating US dollar as the international reserve currency remains in question.

Over the last few years, gold bugs loved the idea that central banks have once again become net buyers of the yellow metal. It not only created an increase in demand that helped send the price skyrocketing, but also made apparent that gold was once again regarded as an asset of value with a foreseeable role in international finance. But, it was not just this shift to gold that we will witness from emerging market economies and Asian central banks, according to the IMF; Canadian (CAD) and Australian (AUD) dollars could potentially play that role as well.

The IMF regularly reviews the “Composition of Foreign Exchange Reserves” (COFER) of central banks around the world. The enlisted currencies belong to the economic giants of the developed world: the US dollar, the Euro, the Pound, the Yen, and the Swiss Franc. The reason being, that the fund considers any currency held in a central banks COFER as easily exchangeable, and appropriate for settling international transactions. As of late, those are two characteristics which suit both the CAD and AUD.

The question is, why? And the answer corresponds with the easy monetary policies of the developed economies that are only looking to prevent the onset of a second global recession. The clearest example is in the US. With no help from their government, the US Federal Reserve has kept their domestic economy afloat since 2009. Expansionary monetary policies have kept both long and short term interest rates at sustained lows, and as a result brought back a housing market that looked all but doomed. Quantitative easing effectively held down mortgage rates to entice new buyers and keep existing home owners from going underwater on their mortgage payments. For the sake of their economy, it was a necessity. The consequence, however, was the devaluation of their dollar, which at times saw a decreasing demand from international buyers and created a shift into gold and other currencies.

Inevitably, it is not the fact that the CAD and AUD act as a substitute to the US dollar as countries would not hold our currencies for the prospective dominance we might carry in international markets in the years to come. It’s the fact that both the CAD and AUD are backed by commodity based economies with sound governments. If we were to see an ultimate global recession, which some extreme economists are predicting, no one will be immune. Moreover, in an ever changing global economy, CAD and AUD represent what might be considered the least dirty shirt.

Is Gold Still an Attractive Investment?

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Going into November of this year, the S&P500 had returned over 13 per cent, yet over the last few weeks we have seen equity markets give much of their gains back (see Figure 1). Gold, however, at this point seems to look rather resilient. As uncertainty in the global market place continues to be a common theme the insurance of preserving an investor’s wealth, which may be provided by precious metals, is becoming more and more apparent.

S&P vs TSX

Two events continue to cast a shadow over the global market place. The more prevalent one as of late is the on-going negotiation surrounding the US fiscal cliff, and this is complemented by the inability of lawmakers in Washington to compromise and work together to put forth a deal. Ostensibly, it seems without doubt that the US Federal government will be able to both cut spending and raise government revenues from taxes in order to avoid economic contraction, but for some reason equity markets do not seem to be reacting in accordance just yet.

The second follows a similar tune of what has continued to roil financial markets since 2009. The Euro Zone has now entered into a double dip recession, and as we look forward the near term outlook is only for it to get worse.

What were economic power houses like Germany and France advanced in the last quarter at extremely modest paces of 0.2 per cent respectively, and this as their growth is forecasted to turn negative next quarter. Furthermore, this recipe for economic contraction is fed by social unrest in the peripheral Euro Zone nations stemmed from continued budget cuts and high youth unemployment.

The greatest threat to Euro Zone remains these populist movements from extremist political parties in countries like Greece that would only act to cut off their nose to spite their face. Where with some potential and hope for a US economy to get back on track, Europe still remains heavily in question.

Since the Sub-Prime Mortgage crises in 2008, global uncertainty has been a common theme continuously associated with financial markets. And while conditions seemed to have calmed in North America and we are not seeing the rampant volatility of the past few years, developed nations are still feeling the burden of sovereign debt and its hindrance on growth remains in place. It becomes very difficult to fathom why a forward looking stock market would produce what might be deemed “normal returns” when countries like Canada and the US advance at around 2 per cent, and Europe collectively is contracting.

The aforementioned reasons add to why gold still remains as attractive as ever. Not even for the potential returns that some investors expect to see as we are over 10 years into what has been a very lucrative bull market. But rather that in periods of economic uncertainty, it is the preservation of wealth that is of greatest importance and exposure to gold plays a role in that.