A Gold Play on the Dollar's Demise

Includes: FXE, GLD, IAU
by: Yaser Anwar

China holds around $700 Billion in U.S. currency in its foreign-exchange reserves. But now, because of fears of a weakening greenback, China's National Bureau of Statistics wants the country to begin trading in its U.S. dollars for other major currencies.

On top of the fear of a slowing economy, investors are concerned that a weakening market has encouraged the Fed to pause in its policy of steadily increasing interest rates thus putting further downward pressure on the greenback. The Chinese now hold the world's largest foreign-exchange reserve. According to latest figures, the Chinese forex reserve has ballooned to an astonishing $941 billion!

China has been increasing its foreign-exchange reserve by an average of $20 Billion each month this year, accumulating most of this in U.S. dollars. In fact, most estimates show that the U.S. dollar makes up 70% to 80% of China's of foreign-exchange reserves. That means the Chinese hold somewhere between $650 and $750 Billion in U.S. currency.

On fears that the U.S. dollar is headed lower, China is slowly but surely trading in their U.S. dollars for Euros and yen. Over the recent months China has been buying the greenback to prevent foreign exchange inflows from boosting the yuan's value. The nation wants to slow appreciation in the yuan, which has risen 1.5% since it was revalued a year ago, as it protects exporter profits. But last week China's National Bureau of Statistics said the country should begin diversifying its foreign-exchange reserves in order to hedge itself against a falling U.S. dollar. In a statement posted on their website, the statistical bureau said, "The U.S. dollar may continue to weaken, increasing the risks of foreign-exchange losses in our currency reserves." This diversification will undoubtedly put a severe downward pressure on the U.S. dollar and cause gold prices to increase.

As the nation gradually moves away from the U.S. dollar and into other currencies, Chinese economists are urging Beijing to significantly increase their gold reserves by almost four times! Bad news for the U.S. dollar is good for Gold. Chinese economists want to quadruple the country's gold reserves! Economists want to increase China's gold reserves so those reserves account for 3% to 5% of the foreign exchange reserves, that translates to about 2,500 tons!

As of today, China holds about 600 tons of the yellow metal in its reserves. This makes up about 1.3% of their total foreign-exchange reserves. More gold reserves will help the Chinese government prevent risks and handle emergencies in case of future possible turbulence in the international political and economic situation. It's difficult not to be bullish on gold right now.

The U.S. current account deficit is likely to contract in the quarters ahead, but only because of a decline in foreign capital inflows. This is likely to result in flat or declining U.S. domestic investment, particularly in the housing sector. There is no doubt that foreign central banks have been the primary buyers of U.S. Treasury debt in recent years, and the primary mechanism by which the U.S. current account (and the growth in U.S. domestic investment) has been financed. The central banks continue to tighten policy, so their absorption of U.S. Treasuries is slowing. When foreign investors fail to absorb the Treasury securities needed to finance U.S. government deficits, those Treasuries are forced into the hands of U.S. investors instead. No wonder you'll see some of the most world's greatest investors are betting against the greenback, from Warren Buffet to Bill Gates and Richard Branson to George Soros!

So how can you profit? Buying ETFs iShares COMEX Gold Trust (NYSEARCA:IAU) or streetTRACKS Gold Trust (NYSEARCA:GLD) and by going long the Euro Currency Trust (NYSEARCA:FXE). FXE represents a cost-effective investment relative to traditional means of investing in the foreign exchange market.