From Dan Denning at the Old Hat Factory: --Here’s a question for...

From Dan Denning at the Old Hat Factory:

--Here’s a question for you: what’s risen more in the last five years, the iron ore price or the gold price?

--If you guessed the gold price, go the corner immediately.

--Despite gold’s recent inspired dash above US$700 (US$731 at this writing) it’s up “only” 135% in the last five years, from US$310 in September of 2005. Meanwhile, the “red gold” of the Pilbara—which is some of the most in-demand dirt in the world—has risen by 189%.

--BHP (ASX:BHP) hit a record high of AU$41.30 during yesterday’s trading. Rio Tinto was up nearly one dollar to AU$102.91. Both companies have ridden the iron ore train and the base metals express to higher highs over the last five years. Let the good times roll!

--“Not so fast,” fast says the prime mover of Australia’s bull market. In today’s Financial Review, Zhang Xiaogang, the chairman of the China Iron and Steel Association, fired a not-so-subtle salvo across the good ship Australia’s bow. His comments should be viewed in context of the upcoming negotiations over the 2008 iron ore price. But they are still interesting as an example of the changing—and not always warm and fuzzy—nature of Australia’s economic relationship with China.

--“It is due to the growth of the Chinese steel industry that the Australian mining industry is booming,” Mr. Xiaogang said in an interview with the AFR. “We need a co-operative partnership ... when the market is good we all take profit together, when the market is bad we share risks together.”

--“From each, according to his ability; to each, according to his need,” Karl Marx once wrote. That just came to mind. Australia is in a for-profit relationship with China. But the Chinese would like to encourage something…more communal.

--“Australian iron ore suppliers and Chinese mills are linked into a chain (and) if one part is broken all of us will fall into the sea,” Mr. Xiogang added.

--“A chain is only as strong as its weakest link,” one saying goes. “Man is born free , but he is everywhere in chains,” wrote Rousseau. “Workers of the world unite; you have nothing to lose but your chains,” wrote Marx.

--Speaking of chains, “Credit card debt hits record high,” screams the headline in the business section of today’s Age. “Australians owe $41 billion, but interest burden steady”. Yes, for now. Until rates go up.

--Back to chains. Has Australia gained chains to go along with its business partnership with China? It’s something to think about over the weekend. Australia’s growing ties with the Far East have brought huge export earnings. But ties are…ties, and Australia’s future is now bound together with China’s.

--Australia’s economic relationship with China is no longer one of convenience but necessity. It’s also, of course, an epic opportunity for Aussie resource companies, their workers and their shareholders. But there are other interesting consequences, not least the larger equity stakes foreign owners are taking in Australian assets. This is a consequence of being a net importer of capital. Is it good? Bad? Who really owns Australia’s corporate profits?

--We have no idea. But we wouldn’t be surprised if China—as Australia’s key resource customer—becomes a bit more assertive in voicing what it thinks Australia’s obligations are in this new cooperative partnership.

--Of course China is bluffing a little, too. It needs the ore. Australia has it. And last time we checked on a map, Australia is closer to China than Brazil. Still, the strategic shift to closer ties with the Far East will have more consequences than just record exports. We just don’t know what those other consequences are…yet.

--The US rate cut rally doesn’t seem to have lasted long. And why would it? Artificial highs never do.

--Debt is the underlying, chronic, corrosive, and disastrous core of America’s problem. Creating more of it is not a solution. The mo#ons on CNBC have told us that the rate cut will fuel growth in the American economy and is therefore bullish for stocks.

--Are these people complete idi#ts, or do they just play them on TV?

--Maybe they did not take a close look at the net foreign purchases/sales of long-term US securities in July. This obscure information is published monthly in the statement of Treasury International Capital flows (TIC) by the US Department of Treasury. Aside from being unsuitable for use in a pick up-line at the pub, it DOES tell you who’s buying and selling long-term, US dollar-denominated assets. And that can be useful if you’re trying to figure out how far and how fast the US dollar is becoming a third-world currency.

--Remember, this data is from July, prior to the chaos in August. In July, people around the world bought US$22 billion US stocks as the Dow closed at an all-time high of 14,000 on July 19th. But behind the scenes - and perhaps in anticipation of August - Asia, Europe, and hedge funds based in the Cayman Islands all sold US Treasury bonds, and most sold corporate bonds too. Central banks sold Treasuries as well.

---Norway—the world’s tenth largest oil producer and third biggest next exporter—was a net seller of US Treasury bonds in July by US$13 billion. Mexico—another key oil exporter for America, was a net seller by US$4.8 billion.

--Imagine that, oil exporters choosing not to recycle petro dollars back into assets denominated in a declining currency. The hedge funds in the Caymans got on board, too. They were net sellers of US$22 billion in US Treasury bonds.

--Memo to CNBC: you don’t make money buying assets denominated in a collapsing currency. We suspect the August data will show more international selling of US bonds, both corporate and government. The big question is if international investors will become massive sellers of US stocks as the dollar depreciates. We’ll see. But you can guess what we think.

--Out of the dollar and into gold and oil, seems to be the response of the markets to Ben Bernanke’ slash and burn policy. There are even rumours that Saudi Arabia, unhappy with the weakening dollar, will unpeg its currency from the greenback. If this happens, it is truly “look at below” for the US dollar—which may buy you 87 cents of the local unit by the end of the day.

--This raises one last point to think about this weekend. How does the European central bank support the dollar without cutting interest rates?

--You might wonder why the ECB would want to support the dollar. The answer is that the strong euro could kill Europe’s economic growth—and with two-thirds of the world’s major economies on the edge of recession, this is worth considering.

--It’s hard to imagine the European economy will do a rip-roaring trade with China and the US if the Euro goes to US$1.50 against the dollar. With China's dollar peg...further euro strength hurts European trade in all directions. The dollar’s fall is Europe’s biggest problem.

--Leaving aside the absurdity that everyone wants to have a weaker currency (competitive devaluations), one thing to watch for is an aggressive central bank campaign to sell gold in the coming weeks. What’s that you say? We’ve been eating too much mercury here at the Old Hat Factory in Elwood? Perhaps…

--It MIGHT sound stupid, supporting the US dollar by selling gold. But the ECB is reluctant to cut rates and fuel inflation, although it floated that very idea this morning in the papers, and if the ECB does cut, gold could soon hit US$100. If it chooses not to cut rates, however, the ECB could tack in another direction to prevent a further a growth killing slide in the dollar/appreciation in the euro: arrest the dollar price of gold.

--A faltering gold price might take the edge off some of the current anti-dollar sentiment. It's a bit of a contradiction because you'd think the dollar's decline would accelerate the diversification of currency reserves, which is bullish for the euro, gold, and high-yielding commodity currencies like Australia’s.

--But—while they’re busy selling US bonds—the world’s monetary mafia may want to create the impression that the US dollar has not already become a third world currency: and they can achieve that impression by selling gold. There are certain to be many buyers of gold today. But concerted and coordinated central bank selling is a definite trick in the bag of the money mafia. Let’s see if the play it.