Tag Archives: commodity


The Euro Zone periphery countries are major news drivers in the markets right now. Developments surrounding these so-called PIIGS (Portugal, Ireland, Italy, Greece, Spain) have become big drivers in not just the euro, but in the whole forex market. In fact, they have been moving stock, bond, and commodity markets as well. No doubt this is something which will carry on for a while.

The Greek bailout is probably the most dominant aspect of the sovereign issues right now. There have been voices on all sides talking about the need for a Greek default and exit from the euro, the extreme negative impact of a default/exit on the markets making that unthinkable, and everything in between on the opinion scale. I want to speak to the euro exit idea in this post.

Think on this question. What happens if Greece leaves the single currency?

Those who favor that kind of solution – or who at least think that's the inevitable course – see that kind of move as being a way for Greece to clean the slate and become more competitive. The latter would be as a result of what would presumably be a weaker drachma than the euro. That would be good for the balance of trade, at least in theory. Sounds pretty good, right?

I'd put forth two potential major problems, however.

First, if Greece goes back on the drachma and it does indeed lose value relative to the euro, what impact would that have on the price of goods for businesses and consumers? Does Greece import a lot from the Euro Zone? Would the weaker drachma produce a price inflation via import prices? That certainly wouldn't help the Greek economy at all.

Second, what happens to the existing debt of government, businesses and individuals that is currently denominated in euros? In a falling drachma situation, the cost of debt maintenance for euro-denominated liabilities would rise. That could have a potentially meaningful negative impact on the Greek financial system and economy, an impact not improved at all if there's a rash of defaults.

There's been a serious issue with this very sort of problem in Eastern Europe where consumers took out loans denominated in Swiss Francs. The Franc has been rising steadily for some time now, making those mortgage payments in local currency terms get more and more expensive to the borrowers. Imagine the impact on your monthly budget if your mortgage payment rose by 40%, which is about how much the Franc has gained against the dollar in the last 12 months.

So the question is what kind of exposure are we talking about here? Does the Greek private sector have a major euro liability exposure?

The impact of a weak drachma on the Greek economy in these sorts of terms is not something I've seen any discussion of so far. If a removal from the Euro Zone is to be contemplated, the questions above would have to be satisfactorily answered.

Looking for answers and more information? Currensee is hosting Charlie Fell, Jamie Coleman and Bob Iaccino on July 21st at 12PM EST to discuss. Register for their free webinar here.

With the end of this month will come the end of the Federal Reserve's second quantitative easing program, known as QE2. On Thursday Currensee will be hosting a panel discussion where the implications of the ending of QE2 will be addressed. You can learn more at http://www.currensee.com/endofqe2

In case you don't really know what QE2 is all about, let me give you the skinny.

Quantitative easing is basically the central bank (Fed, ECB, Bank of Japan, etc.) purchasing securities from the market. This is intended to accomplish a couple of things. One is to stabilize, if not increase, the price of the securities being bought. During QE2 that's been US Treasury bonds and notes. Because bond prices and yields move in opposite directions, rising Treasury security prices means lower interest rates. This isn't as neat and clean as when the Fed changes the Federal Funds Rate or the Discount Rate, but at least it could be said that rates would probably be higher without the Fed buying Treasuries simply because of the demand the central bank represents.

The other thing QE does is inject money into the economy. When the Fed buys Treasury securities it "prints" money to do so. That expands money supply, at least on the base level. That's more money that can be used by the banking system (since just about all money ends up there in one way or another) to create new loans. Of course, in an economy like the one we're in now where banks have tightened standards and borrowers are not as interested in taking out loans, the impact of QE on loan growth isn't much.

Where QE is seen as having a secondary impact, however, is on asset markets. The perception of many in the markets is that the increased amount of money in the system has been responsible for the big gains we've seen in commodity prices. Since the Fed decided to do QE2 because of the risk of deflation (the opposite of inflation), these rising prices (including those in stocks) are perceived by the market to have been the Fed's intention. No doubt this subject will come up during the panel.

The Fed has indicated that it will conclude its $600bln of QE2 Treasury purchases this month. That isn't to say, however, the Fed will be out of the market starting on July 1st. Quite the contrary. The Fed has indicated that it plans to continue reinvesting the principal repayments it receives (both from maturing Treasury securities, and from pre-payment and maturity inflows from all the mortgage-backed securities it bought during QE1). The plan is to keep the Fed's balance sheet (total security holdings) at a steady level, so we will continue to see the Fed buying periodically, just not in the same volume. To that end, it could be suggested that QE2 won't actually be over. I'll leave the semantic decision about that to you.

What we will look to address in the panel is the implication moving forward of the end of QE2 as it relates to the global markets. Hopefully you can join us. http://www.currensee.com/endofqe2


There's a lot of talk these days about inflation and the impact of Fed policy on the dollar and the extension through the weaker dollar into higher commodity prices. Those looking to flame the Fed for its quantitative easing (QE) and generally loose monetary policy point to the falling dollar as the cause for oil going up above $100 and gold crossing $1500. While it's certainly true that the greenback is lower (the USD Index has been as much as about 12% off it's January peak), is the weak dollar really to blame for things like the rising cost of gasoline at the pump? Let's take a look at what the charts have to say about it all.

First is a comparative chart of oil prices in dollars and oil priced in euros. The chart below covers the last year's trading. The red line is the dollar value of a barrel of oil, referencing the left scale. The black line is the euro price of a barrel off oil (using front month futures), with that price on the right scale. Both scales are logarithmic so they express similar percentage moves between noted levels.

Now, the chart above doesn't show relative % gains for oil in the two currencies. Those are +31.3% in USD terms and +22.6% in EUR terms. This is about what we'd expected given the relative performance of EUR/USD over that time. The point of the chart is that aside from wiggles where oil has done better in one currency than the other for a period of time, the pattern of the two lines is consistent. Oil has been moving higher in roughly the same pattern, regardless of what currency we're talking about.

Now let's take a look at gold (again front month futures). Once more, the red line is in dollar terms and references the left scale, and the black line is euro terms referencing the right scale.

In this case, gold is up 29.6% against the USD and 19.4% in EUR terms. Again, that difference can be explained by the change in EUR/USD over the last year, which is as it should be. Here, though, we see a lot more variation in performance. In dollar terms gold has been in a fairly steady uptrend with only two relatively minor retracements. In euro terms, however, the ride has been much more dramatic. Those periods when the EUR line diverges considerably from the USD line are periods when EUR/USD was selling off.

The chart below highlights the variation between how gold and oil trade relative to the dollar. It shows EUR/USD on the top with the correlation between EUR/USD and gold plotted in red and the one with oil plotted in green.

Notice how much choppier the green line is than the red. That means the correlation between oil and EUR/USD is much more fickle than the one between EUR/USD and gold. That said, however, oil has spent more time with a positive correlation (meaning rising oil with rising EUR/USD and falling oil with falling EUR/USD). The gold correlation has been much more balanced. In particular, the gold correlation has been more negative when EUR/USD is falling.

Now, correlation does not mean causality. It just shows how similar the movement patterns are without looking at why that might be. The way I would tend to read the above, however, is to say that rising gold is more a factor of what's happening in the currency arena than rising oil prices. If you think about the implications of increasing money supply (which is what loose monetary policy is), then it makes sense. Gold is something with what could essentially be called a near fixed supply (very slowly increasing), so the more dollars there are the higher the value of gold per dollar (or any other currency). Oil has a different dynamic which is must more closely tied to economic considerations and geopolitics.