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Wednesday, March 23, 2011

EURUSD, GOLD, Crude Oil, Rates, Inflation

As we happen to live in a global world and the financial markets are so much interconnected, it's nice to take a step back and try to observe the whole picture.

There were reports this month about FED and ECB taking different roads. At least on a first sight. The former seems more concerned with unemployment while the latter worries about the raising inflation. Hence the steps the market participants expect from both parties are different. There is a rate hike expected from ECB while the same seems not in line concerning FED. The ECB is expected to raise rates mostly because of higher Crude oil prices inducing higher inflation. That inflation is not a consumer based one (although there might be a consumer part in it). That expectancy of higher rates in Europe keeps driving the Euro higher against the US Dollar. At the same time the Crude (priced in Dollars), conquers new heights helped by the Libyan war and supply fears. And not to forget the hopes of improving economies. This improvement in turn happens to be at danger just because that same high Crude price. So what are the options?

There is no point for the Crude to rise if there won't be improving economies which to initiate the expected-to-grow demand for it. Provide there is a rate hike soon in Europe. My expectancy is for an increase for the year of .25. Higher ones could hamper further the still struggling economies of Europe resulting in even higher Euro and further difficulties for Europe exports. At the same time such a rate increase could happen to be already priced in the EURUSD rate and signal a decline in the Euro/USD pair. The expectations then could be shifted towards a needed US rate hike. Talks of such (as the one of Wharton professor Jeremy Siegel) already started to appear. Meanwhile the Oil resources of Libya could be available again. That combined with the higher Dollar and some profit taking in Crude trading would bring down or at least stop for considerable amount of time the increasing of Crude oil price. And yes, that way the higher prices of Oil would not present a big inflationary danger to the US economy (in line with the hopes expressed by the FED).

The lower crude price would ease to some extend the producer induced inflation in Europe which combined with lower Euro would help it boost its production and exports. At the same time the effect of lower Crude in US on the consumer spending could be zeroed because of decrease in prices and increase in quantities traded. Still that would leave more disposable money for any other types of spending.

All that (together with the increasing demand from Japan for recovering the country from the earthquake) would contribute to the nominal recovery of both Europe and US and bring back the risk appetite. With seemingly departing danger of another shrink of economies the need for hedging would decrease. That includes hedging through Gold. Which brings us to the next point.

GOLD now seems more and more a speculative trade as many more people of all types are getting into it. More volatility is expected and there could be turmoils at least in short to middle term. Generally it stands out nice on the face of every devaluating currency but since it was only a sideway traded metal once, now almost everyone from the big to the small is inviting you to enter Gold. Which itself creates a dangerous environment. This could prove to be a profitable but more risky situation and devaluates to a great extend the hedging characteristic of Gold.

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