Tuesday, February 22, 2005


The water turned red today. Most investment sectors are below sea level. The catalyst was Korea's announcement that the government plans to diversify its foreign reserve holdings. A $200 Billion shift.

Pimco picked up on the report and added its 200 cents. Proving once again that Big Bond Bears can move the whole market. Pimco notes that the trade gap last quarter was $164.7 Billion which means the US has to attract $1.8 Billion per day to pay for the goods.

This kind of talk is the biggest joke but the market takes it seriously. Since the market does then I must also. The fact remains that if the US buys 1.8 Billion Dollars net foreign goods each day, the US must pay 1.8 Billion Dollars, foreigners must receive 1.8 Billion Dollars and foreigners must then have 1.8 Billion Dollars that they need to invest or spend. Greenspan has told us this time and again. The word he uses is arbitrage. Investment banks use arbitrage constantly to maintain level markets.

Gold is the ultimate common denominator. The dollar price per ounce of gold must equal the dollar price divided by the currency price times the currency price per ounce of gold. Without putting in numbers the formula looks a little funky but here it is $/gold=$/FC*FC/gold, where FC is any particular countries currency.

It is mathematically impossible for gold to change in dollar value unless the dollar changes in relative value to at least one foreign currency. For the past few years, the US has run a large trade imbalance (on purpose to pull the world out of recession) and the result has been a decline in the relative value of the dollar. Gold has risen in dollar terms. As the dollar has declined relative to certain currencies, the holders of these foreign currencies have been able to buy US goods at a lower price. Sooner or later, the trade deficit "crisis" is solved. Note: nary a shot needed to be fired or any other action was needed for the "correction" to take place.

The fact that the US is still running a trade deficit means that the US is still in the process of exporting growth to other countries. Gradually the whole world will on average switch from a "recovery" phase to an expansion phase. When this happens, heavy duty capital goods will be in high demand. Big old things like power plants will need to be built. The US sells more than its fair share of capital goods. In a strong world wide market, the US will do well.

Many advisors are telling clients to jump on foreign stocks all the more. They are probably right in the short run. But probably for less time than they think. The market always anticipates future moves and is not priced on the current situation. In other words, when the big move comes, it will come quickly and surprise most investors.

As reported earlier, I went long gold on Friday and I added more to my position today. Gold is parting the red sea. The gold index is up better than 3% today while almost everything else is down. There are a few exceptions. The price of crude oil has soared; up over $2 per barrel. LVLT is the number one stock on the NASDAQ but it dropped so much in recent days that I probably should not mention this one. TXN is still my number one performing stock. It and just a few other high tech issues are up (JDSU is another example). The decline in the dollar should help TXN.

The put-call ratio is down hard today. This market move has a ways to go! Speculators in the past hot markets are about to get flooded, the red sea is closing in on them.