Invest in Gold – and the Chinese Renminbi

Dear Reader,

A few readers have written in, spooked by Bank of America transferring $75 trillion (nominal value) in derivatives from the Merrill Lynch unit to the commercial banking unit. This could be just a clever accounting scheme to save Bank of America some money. BofA has estimated that a two-credit rating downgrade – which has already happened – would mean paying an additional $3.3 billion in collateral or termination fees. Or, this could be in preparation for a possible future bailout.

Regardless of the reason for the move, someone at risk management messed up. They clearly performed a stress test of a two-rating credit downgrade.  I really wonder about the internal conversation after the stress test. Did it go something like this?: "Well, the stress test doesn't look good. If a two-step downgrade happens, we'll have to switch all the derivatives to the commercial banking unit. We're not sure if that's allowed, but we'll find out when we get there." That doesn't exactly sound like a great contingency plan. Even if this isn't related to a possible bailout, I'm concerned by the unconventional risk strategy here.

However, our readers are more concerned with the possibility of the federal government bailing out BofA should these derivatives go badly. Of course that's a real concern; but why is there sudden anxiety over this possibility? Folks, this is 2011, not 2007 – did anyone not expect Bank of America to receive a bailout in the event of another crash? It's the second-largest bank in the US, only recently dethroned by JP Morgan Chase. The Fed and Treasury won't let BofA go the way of Lehman Brothers.

The Fed has bailed out numerous banks, maintained near-zero interest rates for three years, promised two more years of low rates, enacted QE2, and most recently started to twist Treasuries. Perhaps if BofA fails, these guys would show some restraint? Let's not be naïve here. It doesn't matter where those derivatives are – the commercial unit, the Merrill Lynch unit, or the Planet Mars Bank of America branch expansion unit. As long as Bernanke and the boys are in power, those derivatives are insured by the American taxpayer.

During 2008, bailout opponents warned the supporters of creating a moral hazard with their actions. The proponents argued that this was a one-time event. Even some supposed free-market types supported the bailouts. And where are we now? Just look at Europe's situation with Portugal, Ireland, and Greece – and most recently Dexia Bank. Bailouts were not a one-time event – they have become the policy norm for central banks and governments around the world. Unfortunately, the possibility of a BofA bailout isn't news to me. This guarantee has been baked in the cake since 2008.

Next up, Alena Mikhan and Andrey Dashkov of the metals team will report on the Renminbi Kilobar, a new way to buy gold priced in the Chinese yuan.


Renminbi Kilobar – Another Sign of China's Growing Role in the Gold Market

by Alena Mikhan and Andrey Dashkov

This week the Chinese Gold & Silver Exchange Society (CGSE) – a bullion exchange based in Hong Kong – started trading gold quoted in Chinese yuan. The contract, called Renminbi Kilobar Gold, is promoted as offering investors a "double safe haven" – exposure to both gold and an appreciating currency. This line of thought nicely accompanies China's intention to boost the yuan's international appeal. It is expected that this product will attract retail and institutional investors alike from both the Chinese mainland and overseas.

Whether or not the yuan can deliver its part of the "double safe haven plan," Renminbi Kilobar Gold trading in the first day was strong, with 322 traded gold contracts totaling 112 million yuan (or US$17.5 million). The settlement price ended up at 346.95 yuan per gram, or $1,693.9 an ounce.

This is yet another sign of how fast the gold investment sector is growing in China. In 2010 investment was up 70% over 2009. In Q1 and Q2 2011 gold investment rose by 123% and 44% over the same quarters of 2010 respectively. At such a pace, the Chinese market seems to be swallowing virtually every ounce of gold it is offered. Haywood Cheung, President of the CGSE, expects their new product to boost these already-growing volumes.

To make trading convenient for overseas investors, trading hours have been set for 8 a.m. to 3:30 a.m. the next day, Hong Kong time. Traders may choose to settle their trades either in cash or with spot gold delivery. Also, there is apparently a mechanism for investors to buy with US dollars.

The main goal of this investment tool seems to be promotion of the Chinese currency across the region and on the global scale. However, the impact – intentional or otherwise – on Chinese demand may potentially have positive implications for the price of gold.

We would not be surprised to see a similar offering in India soon and will continue monitoring such developments to make sure our readers are among the first to know if anything changes.

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Additional Links and Reads

Reid Signals Government Jobs Must Take Priority over Private-Sector Jobs (The Hill)

Here's a fabulous quote from Harry Reid: "It's very clear that private-sector jobs have been doing just fine; it's the public-sector jobs where we've lost huge numbers, and that's what this legislation is all about." According to Harry Reid, the teachers and first-responders are suffering in this economy while everyone in the private sector is doing just fine.

Well, let's take one of those inconvenient looks at the facts. According to the Bureau of Labor Statistics, state government education employees increased from 2.328 million in 2007 to 2.397 million in 2011, a rise of 69,000. However, local government education employees went from 8.019 million in 2007 to 7.834 million in 2011, an 185,000 decrease. On net, that's 116,000 jobs lost over four years. Given these numbers, teaching jobs would have to drop off a cliff to meet Reid's estimate of 400,000 jobs lost.

Over 100,000 jobs lost is definitely not a number to ignore, but let's take a look at something in the private sector… construction, for example. In 2007, 7.575 million were employed in construction. By September 2011, only 5.551 million remained in the industry, a 2.024 million drop. That's over 17 times the number of lost teaching jobs.

What Percent Are You? (Wall Street Journal)

The Wall Street Journal has a nice income percentile calculator. With Occupy Wall Street claiming to represent the 99%, see where you fit in. Personally, I dislike the whole 99% slogan. Just because I'm not in the top 1% doesn't mean my interests align with every other person in the country. This is much like the argument for uniting the middle class taken to the extreme. Just because I'm in the middle class doesn't mean I share interests with every member of the middle class either. This whole idea of class identity and interests based on income level closely follows Marxist lines. No wonder Occupy Wall Street is a big fan of his ideas.

Keystone Pipeline Controversy

The Keystone pipeline is a big controversy, but should it be a much smaller issue? As Marko, who sent me the image below says, "What's another pipeline amongst oil-addicted friends? " He's got a good point.

(Click on image to enlarge)

That's it for today. David Galland should be writing tomorrow's Dispatch. Meanwhile, I'll be catching up on a ton of reader emails, so if you haven't heard from me, expect a response tomorrow. Thanks for reading and subscribing to Casey Daily Dispatch.

Vedran Vuk
Casey Daily Dispatch Editor

Oct 20, 2011