- Crimean Independence movement sparking gold and euro rally.
- U.S. dollar breakdown in process; will Russia dump dollar for oil?
- Gold rallies to $1370 on military conflict and increased fund flows.
Gold (NYSEARCA:GLD) broke through overhead resistance at $1361 on a mix of currency and geopolitical worries. In my last article on this subject, I noted that the ECB's refusal to alter its current monetary policy put a strong bid under the euro (NYSEARCA:FXE) as traders abandoned the short euro/long U.S. dollar (NYSEARCA:UUP) trade last week. Since then, the tensions over the pending bifurcation of Ukraine have risen. Along with it, so have worries about the U.S. dollar, which has broken down below a significant support level as measured by the trade-weighted USDX.
Gold pushed up through the October high of $1361 on Wednesday due to increasingly bellicose rhetoric coming from the G-7, particularly the U.S. and the EU. But as I noted last week, the EU is in a major bind due to its dependence on Russian oil and gas, especially in the weak southern region known collectively as the PIIGS. Beyond them, the most important EU nation dependent on Russian energy is that of big-daddy Germany, who imports 36% of its natural gas from Russia.
And this is why the EU will not push too far in Ukraine over whatever moves are made by those in the eastern half of the country who want reunification with Russia, or by Russian President Vladimir Putin in facilitating them. The U.S., on the other hand, has a lot to gain by keeping the Russian economy weak as the petrodollar system is breaking down and could flip at any moment.
This is part of the reason why the Obama administration announced a small release from the U.S.' Strategic Petroleum Reserve - 5 million barrels - to spook traders into selling oil futures and push the price down to hurt Russia's income. In reality, it is a non-event that will be faded in the coming days.
Rubles for Oil?
Investors have to be aware of the possibility of Russia repudiating the dollar completely and accepting other currencies for its oil and gas in the event something stupid - read military engagement - were to occur.
While I have been worried that U.S./Saudi relations have broken down to the point where the Saudis may accept something other than dollars for their oil as the game is played out in Eastern Europe, it is becoming more likely that Russia may, in fact, be the first domino to truly fall.
The Russian ruble has been under constant attack all year, having fallen nearly 11% year-to-date to around 36.5 to the dollar. With the euro breaking above the important resistance at $1.3905, it should be clear sailing to $1.40 and then $1.42. Why would Gazprom (OTCPK:OGZPY) accept euros, gold, or force customers to buy rubles to pay for their oil?
Accepting rubles would be good for the ruble, but the bigger win for Russia would be to accept euros or gold. Russia is already funneling its oil and gas profits back into its gold reserves, having crossed the 1000 tonne mark in January. Russia's official gold reserves are now 1035.481 tons.
The effect on the dollar if Russia were to make this move, which they have threatened to do, would be catastrophic as the USDX would plunge, gold would skyrocket and the EU would be heavily incentivized to back off its piggy-backing on U.S. aggression in Eastern Europe. A strong euro would ensure that Europe gets its much-desired price break from Russia for the cost of its energy.
Updating the charts from my last article we can see that the euro price of Brent crude (NYSEARCA:BNO) is threatening a move back to €75 ($104)/barrel [see above]. Moreover, the move up by both the euro and the Japanese yen (NYSEARCA:FXY) has come to pass, and the USDX is now flirting with a weekly close below the December low of 79.69.
Gold to Shine
With the U.S. continuing to posture about military support in eastern Ukraine after Wednesday's statement by the Joint Chiefs of Staff, the markets are still reacting mildly to the situation, putting strong faith in the "cooler-heads will prevail" theory. I am not as sanguine as the markets about such an outcome at this point as we approach the March 16th referendum on Crimean reunification.
Gold has responded along with U.S. Treasuries (TLT), which saw a strong 10 year auction this week and yields dropping back near 2.72%. So, the safe-haven trade is continuing, but equities still want to believe in the power of the bull and the Fed's money printing with the S&P 500 (NYSEARCA:SPY) still hovering above the 1845-1850 technical support level.
As long as the threat of military conflict continues, gold will continue to get a strong bid and push its way towards $1435. With holdings of GLD on the rise again, U.S. investors are piling back into gold in a big way. GLD has seen $642.88 million flow into the fund since the beginning of the year, with the lion's share of that occurring in recent weeks.
In short, the stand-off between Russia and the U.S. over Ukraine is a major move in the long-term geopolitical game of energy and currency dominance. Neither side can truly afford to back down, and for that reason, gold will be the main winner here. I expect commodity prices to remain depressed until a clear breakdown of the USDX occurs. When that happens, currency effects will take over and oil, natural gas and copper should all begin to move higher in US dollar terms.
Additional disclosure: I own physical gold, silver and a small dairy farm.