Currency and Gold Update (April 13, 2006): From gold to Euro, Yen and Yuan ETF's?

ETF stands for "exchange traded fund". The gold ETF has become a big hit on Wall Street. Quite a few observers attribute the recent run up of the price of gold to the popularity of gold ETF. A gold ETF sells shares just like common stocks, and uses the sale proceeds to buy and hold physical gold bullions. Its issued shares are traded on stock markets. If its share price moves above the index target, for example, one-tenth of the price of one troy ounce of gold at the spot market, the ETF will issue more shares and use the new sale proceeds to buy more gold bullions. If its share price drops below the index target, it allows large investors to exchange their shares for the physical gold bullions. By those mechanisms, the share price of ETF will be kept close to the index target and move in tandem with the actual price of gold in the spot market. Gold ETF's are attractive to individual investors and some mutual funds alike. Before the gold ETF's, it is difficult for individual investors to literally buy and sell a small amount of gold bullions that requires storage and proper certification. Another way to invest in gold is to trade in futures, but that is beyond the reach of many individual investors. With gold ETF's individual investors just buy their shares like they buy common stocks, and thus a substantial number of individual investors have joined the gold investing, bringing along a sizable amount of new capital into the gold market. Many mutual funds are forbidden to trade in futures and hold physical commodities like gold bullions, but they can buy into the shares of gold ETF's. Especially at the time of rising gold price, those mutual funds have strong incentive to buy into gold ETF shares to enhance their performance at one hand and use their holding of gold ETF shares as a hedge against unforeseen disasters that may severely depress the prices of their other share holdings. Thus the factors of individual investors and mutual funds converge and the price of gold is getting an added push due to the popularity of gold ETF's.

Many investors are buying gold as inflation hedge. There are two different lines of thinking about the danger of inflation and gold buying. The first line points to the ever-rising commodity prices, like oil price. Though the rising commodity prices have not yet triggered the outbreak of inflation, the fear is that at certain point the inflation floodgate will open. According to this line of thinking, the price of gold should be synchronized to the price of commodities, especially the price of oil. The second line of thinking about inflation is the fear of the collapse of US Dollar that will lead to substantially higher import prices and thus a much higher inflation rate in US. The investors following the second line of thinking should be combined with investors who consider gold as the hedge against the collapse of Dollar no matter inflation or not. The portion of gold buying investors that use gold as the hedge against the collapse of Dollar is probably quite large. The interest point to observe is that when Dollar collapses, it goes down drastically against foreign currencies, like Euro, Yen and Yuan. One may ask why those investors that use gold as the hedge against the collapse of Dollar do not directly buy foreign currencies as the hedge; certainly holding foreign currencies directly is no more risky than buying stocks or gold. The answer to this question is that there is no practical way for US based individual investors to buy foreign currencies directly. US brokerage accounts usually do not allow investors to buy foreign currencies. If one goes to major international airports in US, one can find an empty currency exchange counter with the exchange rate among various currencies posted. The bid-ask spreads between major currencies are typically about 20%, whereas in the actual currency markets such bid-ask spread is only a fraction of a percentage point. If a US investor is lucky and finds a commercial bank that allows the investor to open a foreign currency denominated account, the bid-ask spread will be no better than the spread at major US international airports. This means that the practical way for a US based investor to invest in foreign currencies is again through the highly speculative futures trading. Similar things can be said for many mutual funds looking for some hedge against the danger of the collapse of Dollar. Thus the demand for foreign currency based ETF is definitely there. At the time when financial markets are eagerly creating various ETF's, from gold to silver and crude oil, and attempting to extend to various other metals and commodities, the potential of foreign currency based ETF's will certainly not be overlooked.

The rise of gold price will unnerve sock markets and bond players but does not pose a direct threat to the globalization scheme itself. However, the rapid rise of foreign currencies against Dollar means the collapse of Dollar and will cause the current globalization scheme, which is based on the explosive growth of US trade deficit, to be destroyed. If foreign currency based ETF's become the reality, at the beginning it will not pose as a threat to the globalization scheme. However, once some sign of crack appears in the scheme of artificially sustained Dollar, by foreign governments like Japan, China, Taiwan, South Korea and so on, foreign currency ETF's will serve as convenient channels for a vast amount of US capital to flow into Euro, Yen and Yuan. The torrent of Dollar selling and foreign currency buying will rapidly overwhelm all the foreign governments combined, the free market mechanism will finally take back the control of currency markets from manipulative governments and will re-impose its traditional policing mechanism, that is, push the currency of large trade deficit country, US, down sharply to end the global trade imbalance. That is why we need to keep an eye on the probable emergences of Euro, Yen and Yuan ETF's.