Several Geopolitical Events That Could Prove Negative For The Dollar And Bullish For Gold - Part 1

Includes: FXE, GLD, UDN, UUP
by: Power Hedge


There have been several geopolitical events that have occurred recently that show an increasing distrust in the U.S. dollar by foreigners.

Foreign central banks have actively been reducing their holdings of Treasuries all year.

Some central banks that have been dumping Treasuries have been buying eurozone assets.

Click here to read Part 2.

Click here to read Part 3.

A few weeks ago, I wrote an article that stated that one reason why gold (NYSEARCA:GLD) could be a good investment right now is that two major creditors to the U.S., the nations of China and Russia, have been quietly showing a lack of faith in the U.S. dollar and so have been quietly selling off their holdings of U.S. Treasury securities. One source of evidence that supports this is that China reduced its holdings of U.S. Treasury securities by $47.8 billion in December. This was more than made up for by the purchases of Treasury securities by other foreign nations, with tiny Belgium being by far the largest purchaser. This was pointed out to me in the comments with at least one reader noting that December witnessed the greatest volume of foreign Treasury purchases in history. However, since that time, there have been further developments that result in some skepticism regarding these figures. I will lay out those developments in this article and let the readers make up their own minds.

The United States Federal Reserve publishes a data series that is very under followed by most financial pundits, although professional bond managers and vigilantes assuredly do. This data series is called "Treasury Securities Held in Custody for Foreign Official and International Accounts" and it shows us the foreign sentiment towards U.S. Treasury securities. It does this by tracking the total face value of Treasury securities that the Federal Reserve holds in custody for foreign nations and foreign central banks. The decided trend here shows a very strong lack of faith in the U.S. dollar on the part of foreigners.

On March 14, 2014, Zerohedge reported that this data set showed that for the week ended March 12, 2014, foreigners sold off $104.5 billion of Treasury securities. This was the biggest sell-off of U.S. Treasury securities by foreign central banks and nations in history. Admittedly, this data set only includes those Treasury securities that are being held in custody at the Fed. So, it is possible that the foreign central banks did not sell off their Treasuries but instead merely moved them to another custodian. But it would not make much sense to do this as the Federal Reserve is by far the most convenient custodian for these assets. Therefore, moving these assets out of the Federal Reserve would show a lack of faith in the Federal Reserve, which would imply a lack of faith in the dollar by association. Zerohedge also provides an interesting quote from Societe Generale that states that there are signs in the currency markets that show that foreigners are indeed selling off Treasuries.

"Weekly data from the Fed for US Treasury securities held in custody on behalf of foreign institutions and central banks fell sharply over the past week and may offer a plausible explanation as to why the USD has been offered pretty much all week against its major counterparts. EUR/USD in particular has stayed strongly bid since last week's council meeting (to the bemusement of the ECB) and touched a high of 1.3967 yesterday before easing back after the exchange rate comments from president Draghi. The reduced appetite for USTs and strong demand for EUR debt and equity securities underlines the difficulties the ECB is encountering to stop the strong EUR from reducing inflation expectations in the Euro area.

Foreign holdings of US government securities held at the Fed dropped by a whopping $104.5 billion in the week to Wednesday 12 March according to the data published overnight (see chart below). This marks the biggest single weekly fall on record and compares with just a $13.5 billion drop the previous week and a 4-week average fall of $1.5 billion. The previous largest fall came in mid-2013 (26 June, a week after the FOMC meeting) when holdings fell by $32.4 billion. The selling over the last week coincides with the latest US employment statistics, a run of weak data from China, and the escalation of the situation in Crimea and Ukraine.

Russia has threatened to respond with sanctions of its own should economic measures by imposed by the EU and the US after the referendum in Crimea this weekend. Russia currently holds $138.6 billion of USTs (based on December data) and the country has been a net seller for a combined $11.3 billion of USTs over the last two months for when data is available. China sold $47.8 billion alone in December. The latest Treasury International Capital (TIC) data for January are only due next week so we won't find out officially until May how much Russia's US government debt holdings dropped in March."

The evidence that foreigners are turning against the dollar is actually much stronger than just one week in which there were record sales of Treasuries. Here is a chart from the St. Louis Fed showing the amount of U.S. Treasury securities that the Fed held in custody for foreigners in each of the past 52 weeks.

Source: St. Louis Fed

As this chart shows, foreign central banks have been gradually reducing their holdings of U.S. Treasury securities since the beginning of 2014. The chart shows that foreigners have not been selling off their U.S. Treasuries every week. In fact, some weeks show an increase in the amount of foreign holdings of Treasury securities held in custody at the Fed. But the overall trend this year has been decidedly negative.

So, what have the foreign nations that have been selling Treasuries been doing with the proceeds? Well, Societe Generale (above) suggests that many of them have been diversifying into the euro and into the bonds issued by eurozone governments. According to analysts at the bank, this is one reason why the euro continues to show impressive strength despite the efforts of the ECB to weaken it relative to the dollar.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.