Gold continues upward march - long term diversification strategy by central banks

Gold is up over $140 per oz just in the month of October. The demand is driven by more than private investors but continued interest by central banks. The central banks of the developed world are still the dominant holders of gold, but that mix will change with the growing of foreign exchange reserves. The emerging markets have moved from precautionary holding of reserves in case of a crisis to now FX reserves being driven by exchange rate policies. The problem is that they do not want to hold all of their foreign reserves in dollars. Even small diversification into gold is driving the price higher. (Graphs from World Gold Council.)

Gold holdings by central banks declined for most of 2000-2008 period. The largest holders cut their exposure but now we are seeing a reversal in behavior. China has grown to be a larger holder than Switzerland. While there may be a decline in buying as the price levels get higher, the diversification motive will not change as long as the loose monetary policies and higher debt levels in developed countries continue.

A shift in thought by CFA's - no longer believe in efficient markets

The British CFA recently asked members for the first time whether they trusted in "market efficiency" - and discovered more than two-thirds of respondents no longer believed market prices reflect all available information. More startling, 77 per cent of the group "strongly" or "very strongly" disagreed that investors behaved "rationally" - in apparent defiance of the "wisdom of crowds" idea that has driven investment theory.

from FT

So what do they believe? This is serious if after 3+ years of testing the CFA holder do not believe win the foundations of finance. Should the CFA ask for respondents to give back their certificates? How do you do finance if market prices can move anywhere?

Clearly, the extreme versions of efficient markets were misplaced and only useful as a simplifying assumption, but it would be difficult to throw out the concept without an alternative view.

FDIC issue is a reason for scramble to Treasuries

The government-administered insurance fund that protects depositors fell $8.2 billion into the red for the first time since the fallout from the savings-and-loan crisis of the early 1990s as the pace of bank failures accelerated in the third quarter. Meanwhile, the number of “problem banks” that run the biggest risk of collapse increased to 552, from 416 in the second quarter.

The agency recently approved plans calling for industry to lend money to the insurance fund by ordering banks to prepay annual assessments that would otherwise have been due through 2012. So we are paying Peter today and have nothing for Paul in the future. The FDIC could add another assessment or tap a Treasury line of credit. The cost will be borne by the banks or taxpayers. When banks have to pay the assessment, yields go down, so there is more reason to hold Treasuries. The problem is with smaller banks who have high commercial loan exposure and lend to small businesses. This is a below the market risk which can be very relevant as we end the year.

RMB appreciation - will it make a difference?

Everyone wants the RMB to appreciate. The US. The EU. All of the Asian countries who are competing for exports. Yet, the impact of a change will have limited impact on the trade balance. It has been estimated that a 10% appreciation will led to a little over a 10% cut in the trade balance which would take it from a $400 billion t a $355 billion surplus. This is not what most countries would like to see. In fact, when the RMB did have an appreciation of 20%, there was no effect on the trade balance. The trade surplus just grew. Additionally, because the RMB has been tied to the dollar, the other Asian countries have actually seen an improvement in their currency position when the dollar gained ground last year.

The imbalance problem will not be solved by a change in currency prices. there has to be a more fundamental change in consumption behavior across Chimerica.