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Is the buck really set to come over all bullish?

21 February 2010 (Times Live)

Jim Jones looks at the US dollar with new eyes in a time of metals uncertainty

Are we at another turning point? One of those changes in direction that can lead to fortunes being lost or made? Have we reached a point at which the dollar reverses its declining trend, in place since 2002, and at which the prices of everything - currencies, commodities and even money itself - move into new territory?

It's the question Fortis Bank and its Virtual Metals consultancy are asking. Certainly the dollar has been in slow, overall decline these past 30 years, but that period has been marked, Fortis says, by two great dollar bull markets - in 1980 to 1986, when the dollar rose 56% against a basket of other major currencies (then fell 40% in two and a half years following the Plaza Accord); then, from 1996 to 2002, the dollar put on 40% (before heading into a six-year, 38% decline).

Most recently, since mid-2008, we have had the strengthening, weakening and strengthening again, which, Fortis suggests, could presage another mighty dollar bull run. And Fortis isn't alone. Noted economist and contrarian thinker Nouriel Roubini has been pointing for months to a dollar upsurge as investors turn to the safe haven of US bonds.

Conventional wisdom, backed by some historical data, is that periods of dollar strength relative to other currencies are accompanied by generally declining metals prices and vice versa. Are we facing that prospect now?

For the gold bugs, is their favourite metal set for the sort of price tumble that followed its 1980 (then all-time) high of $850/oz? But correlation does not imply direct causation, Fortis says. The more important the US market for particular commodities, the greater the degree of correlation.

Movements in metals prices are frequently more exaggerated than the move in the dollar's external value. Fortis cites the example of gold: when gold investors see a strengthening dollar and weakening gold price, they sell bullion and their selling pushes the gold price even lower. The trend can become self-feeding.

This might be wholly applicable in the case of gold, which largely trades in a speculative market these days. Other factors are also at work for other metals.

In the 1996-2002 dollar bull market, dollar-denominated metals prices in general rose as (particularly) Chinese demand for commodities far outweighed the exchange rate's effect on prices. But by the 2008-2009 bull run, financial and economic collapses combined to cut demand for commodities, helping to reinforce the effect of the dollar's exchange rate and pushing commodity prices down.

Clearly, commodity pricing is far more complex than a simple inverse relationship to the dollar. So what is the outlook for the principal traded metals?

Gold, the most publicised, is in a strange position. Net purchases by gold ETFs have been particularly flat since the start of this year, implying wary investor support for the metal. If the dollar does take off - perhaps as individuals turn to it as a safe haven and as interest rates rise - gold's dollar price will come under pressure.

But while inflation fears persist and the US debt/deficit situation remains dire, gold will enjoy some support. Fortis predicts a price range of $1020/oz to $1120/oz in the near term - that's weeks rather than months.

Contrast this with platinum, up and down all over the place since its January 20 peak London fix of $1627/oz. The main driver in the first weeks of January was burgeoning US ETF buying, but that has eased off and, if anything, UK ETFs have been net sellers for the past few weeks.

And the platinum group metals have yet to take direction from the world's car markets. US auto sales are about 30% down on their "normal" levels of 2008; the Europeans are unimpressed by the closing of "cash-for-clunkers" programmes; and China has still to show that domestic car sales will match some optimistic estimates.

Near-term, then, Fortis is cautious, predicting a range of $1450/oz to $1550/oz for platinum, and $390/oz to $440/oz for palladium. And these estimates are based on expectations of supply tightness due to production constraints at South Africa's platinum mines.

Fortis sees aluminium in oversupply and is looking at a near-term price range of $1900/ton to $2150/ton, against the metal's current three-month price of fractionally less than $2100/ton.

Much the same goes for the bank's copper price prediction. Near-term, the price is predicted at $6100/ton to $7000/ton against the current three-month LME price of less than $7000/ton.

For nickel, an average of $20000/ton is predicted for 2010, only fractionally higher than the current three-month LME quote. Outside China, demand for stainless steel is in the doldrums and warehouse nickel stocks are high.

Essentially, although Fortis believes that a stronger dollar will affect some metals' prices, the swing factor remains China's demand for commodities. And that, in its turn, is affected by the country's ability to export to economically troubled OECD countries.

In the meantime, look for a strengthening safe-haven dollar with all that this might entail.

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