From today's Gartman Letter...... (12-17)

"COMMODITY PRICES ARE STRONG and they are so despite the strong US dollar. We do not find that nearly quite so odd as others seem to find it, but that is indeed the reality of the day thus far. We’ll turn then to the “commodity” most often associated with a weak US dollar, the precious metals and most notably gold, noting that gold is trading steadily over the course of the past twenty four hours in US dollar terms, but it is trading quite a good deal stronger in terms of the EUR, Sterling and even the Yen. That we find noteworthy, and that we find impressive.

As we write, spot gold is trading very near to where it was yesterday morning as we marked prices here, and yet the dollar is trading nearly 1.5 EURs for the better. In other words, where spot gold was trading €780/oz yesterday morning it is trading €784.70 this morning, or 0.6% higher. Those who found fault, or took exception, to our thesis that we would be well served by owning gold in foreign currency terms now see the merit to our thesis. In owning gold in non-US dollar terms one gets the benefit of owning gold, but one has hedged away one’s implicit exposure to the US dollar inherent in a long position in gold in dollar terms. The volatility of owning gold is reduced, and one’s ability to weather corrections along the way is enhanced.

To that end, we are asked “How do we get long of gold in foreign currency terms?” We’ve had the question asked so often that we thought it wise to explain it here this morning. Simply put, there are any number of ways to be long of gold, all of which carry an implicit dollar exposure. One can buy gold futures or one can buy the gold ETF. We are ambivalent to either, for the “arb” between the two does keep them almost perfectly in line, one with the other. The “beauty” of the ETF, however, is that one can adjust the long position in dollar terms perfectly, where as the gold future, being 100 ounces of gold, carries a rather sizeable exposure. Thus, at present, one contact of February gold is “worth” approximately $113,000, or one can create the same value by owning $113,000 “worth” of the ETF, or at last night’s close 1017 shares.

The real problem here is creating an equal dollar sum on the other side of the transaction. One can hedge away the dollar risk of a long gold transaction by selling the spot FX market and then rolling the position forward each day, which is cumbersome but quite effective, or one can sell short EUR, or Sterling, or Yen futures on the IMM, which is easy but creates dollar valuation problems, or one sell short the currency ETFs (FXE, FXB or FXY for the EUR, Sterling and the Yen respectively), which makes dollar equivalence very easy but borrowing these ETFs can prove problematic. The easiest way, for the public anyway, is to use the IMM futures.

The problem with the IMM futures is that they are for fixed sums of each currency. For the EUR that is 125,000 EURs, which at the moment, given the spot rate is "worth” approximately $180,000; for Sterling, which is 62,500 pounds, that is approximately $101,400, and for Yen (1.25 million Yen) that is approximately $111,250. Thus, if we buy one futures contract of gold and were to sell one EUR future, we’d have an excess long dollar position of approximately $67,000, which can be “hedged” away by owning a bit more GLD. One gold future is almost perfectly equal to One Yen future but it is worth a bit more than that of one gold future, and one Sterling future is worth a bit less. Thus, if one “did” one contract each of Sterling, the EUR and the Yen, and one did three contracts of gold, one’s dollar risk would be approximately $54,000 (rounded off to the nearest thousand dollars), which could itself be hedged away by buying that much more GLD.

The beauty of the currency ETFs is that one can do precisely the right amount of dollars on that side of the transaction to equal one’s gold futures position, but as noted above, borrowing the ETFs to get short of them may be problematic, and often is. But it is not an insurmountable problem, obviously.

Finally, one might wish simply to buy gold via the ETF or futures and then buy the UUP (the dollar “UP” ETF) in the amount perfectly dollar equal to the value of the gold future. At present that means that one would buy 4,967 UUP for each gold future bought, putting approximately $113,000 of both on each side of the ledger. For the public, this is probably the best and easiest way to effect the trade; for professionals and institutions there are better, more precise ways, to effect the trade, the ultimate affect of which is to avoid dollar exposure and to gain exposure to gold priced in currencies other than the US dollar."

Life after the Treasury was hard for Tim....



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