Alex says that despite the USD whiplash, "The AUD gold price is fairly stable. The AUD price of gold is therefore more of a true measure of gold's strength against all other currencies; or possibly the Euro gold price is a better example as the Euro is a broader based currency. Big changes in the gold price in the AUD or EUR would be more reflective of true supply and demand dynamics."

Ah. So for gold to move in Aussie dollar terms there has to be more than just a big bear market in the USD. Demand for gold has to rise globally.

Alex says, "China's change in policy regarding gold ownership could be a huge influence on increasing demand in coming years. You have hundreds of millions of middle class Chinese being encouraged by the big-man to buy and own the stuff."

And the investment conclusion? "At least Australian producers are not going to be quite as exposed to the whiplash price movements of the USD gold price. Cheaper production costs must be the key. That's what you want to look for to begin with." We'll keep you posted on what Alex finds in his research.

What about the rest of this market, though? Have the Feds and the politicians managed to engineer a recovery without any more deleveraging in a massively leveraged economy? We know they haven't repaired the quality of the troubled assets in the financial system. But has their hocus pocus harem skarem managed to convince investors that it's okay to lever up again?

Maybe so. We'll see. We reckon it will be nearly impossible to forestall further write downs in assets that were bought with credit (houses, shopping malls, stocks, you name it). There is too much global capacity...too much money tied up in assets not producing anything...too much household debt...and too much government borrowing that's failed to produce cash flow that can pay interest and principal on that debt.

But hey. All those are just troublesome details. It's Friday. Let's enjoy the Ponzi Party while it lasts. Just don't forget to plan for the end.

Dan Denning
for The Daily Reckoning Australia

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A report on U.S. payrolls showed that the American economy shed around 491,000 jobs last month. This was less than expected by forecasters and the least amount of jobs lost in the U.S. since October of last year. So in a manner of speaking, losing half a million jobs in a month is an improvement.

Financial markets were encouraged by this news. In fact everything seems to be encouraged. The Dow was up. The S&P was up. Gold was up. Oil was up. Up, up and away!

Not even the news that Bank of America may require US$34 billion in new capital could bring the mood on the Street down. The results of the 'stress tests' have been duly leaked so the market can digest the rumour (and sell the news). The good news is that Morgan Stanley, JP Morgan, Goldman Sachs, and American Express all seem to have 'passed' the test and do not require additional capital (at least according to government accounting). Of the 19 backs quizzed, it looks like 10 will need more capital and 9 will not.

Whether the 'stress tests' really tell the truth about the banks or not doesn't seem to matter at the moment. There has been a huge cloud of uncertainty hanging over the banks (and thus the market) regarding their solvency. Just the idea that the cloud may be dissipated (and that the economy is free to recover) is sending stocks higher.

Don't take our word for it. Look at the Aussie dollar. Look at commodity prices. As we said yesterday, risk is back. If we get a resumption of the carry trade (borrowing in USD and Yen to buy higher yielding assets) it can only be good news for Aussie stocks. We just don't know how long the party will last.

Of course no one really knows how much capital the banks will need over the coming years to offset losses. It could be a lot more. U.S. real estate site Zillow.com says that 22% of Americans owe more on their homes than their homes are worth. That's what we call "negative equity." If it were true, it would mean more than 20 million homes are underwater.

Do you think the stress test included the possibility that 20 million Americans would default on their mortgages? Probably not. It's an almost apocalyptic number. But it IS a credit depression. And it WAS a pretty big bubble in housing.

Here in Australia, everyone's going berserk spending government money. Retail sales hit $19.3 billion in March. That was a 2.2% gain over February. Nothing like a little national retail therapy to deal with a structural problem in the economy, is there?

That structural problem-similar to America-is an economy built on consumption and housing and the financial industry. That said, this looks like a rally you don't want to get in the way of.

Even Rupert Murdoch thinks "the worst is over." "There are emerging signs in some of our businesses that the days of precipitous decline are done and that revenues are beginning to look healthier," he said, after saying that he expects the full year operating profit to be 30% lower than last year's figure.

He also said he believed advertising dollars are fleeing print newspapers for good, to the web. And it's worth noting that one of Murdoch's properties-the Wall Street Journal-is one of the few newspapers that charges for online content. It's not a coincidence that the Journal is one of the few profitable papers in the U.S. Its circulation is rising.

Hmm. Charging for on-line content. It's a thought.

Until tomorrow...

Dan Denning
for The Daily Reckoning Australia

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Symmetrically, a decline of the AUD/USD makes gold more expensive for them. This foreign currency (FX) effect (also known by traders as currency risk) is a real matter for local investors.

FX markets in general and the Australian Dollar in particular had impressive volatility in 2008, especially during the second half of the year. If it continues in 2009, you'll want to understand the relationship in order to devise your own gold strategy.

On the chart above, the black line represents gold in Australian dollars (we called this composite "Aussie gold"), while the green bars represent the currency pair AUD/USD. There are three different phases that are distinct.

1) Phase 1 from August 2007 to March 2008 where "Aussie Gold" climbed sharply despite the fact that the AUD/USD exchange rate was rising too. It means that at the same time, gold prices in USD were rising faster than the AUD/USD.
In details, it means that, the AUD/USD ( how many US Dollars for ONE Australian Dollar) rose by 11% roughly between September 2007 and March 2008. For the same period, gold (therefore how many US Dollars for ONE ounce of Gold) rose by 31%
As a result, both the AUD and gold appreciated against the USD, but gold appreciated much faster. That's why the Aussie gold price (how many Australian Dollars for ONE ounce of gold) also climbed sharply. What does it all mean? It means that gold appreciated against AUD!
The Aussie gold price is a function of the velocity of the AUD/USD compared to the velocity of gold. If AUD/USD appreciates faster than gold, then the Aussie gold price declines. If gold appreciates faster than AUD/USD, then the Aussie gold price rises.

2) Phase 2 from March 2008 to September 2008 where the "Aussie gold" was cheaper as gold in USD was correcting while the local currency jumped to historical highs until July, then crashed.

3) Phase 3 from September until now where gold prices on the international markets are consolidating and rising again whereas the AUD/USD has been falling to low levels not seen since 2003. As a result, the "Aussie gold" is soaring.

Since last October, we can see that the Aussie gold price is reaching historic highs. Because of the crash of his currency on the FX markets, a local must pay today $1,250 AUD to buy an ounce of gold. At mid-August last year, the cost for the same ounce was only $917 AUD. It's a 36% increase in 5 months!

What is the conclusion of that?

Well, we have calculated the correlation between gold and the Australian currency, both the strength of their relationship and the degree of their relationship. From 1991 to date, this correlation is equal to 81%. Gold and the Aussie are positively correlated, as they typically move in the same direction because they are both traded against the US Dollar. But they don't move at the same pace. And this is that difference of pace or velocity that drives the Aussie gold price.

On a historical basis, a strong Australian dollar is NOT a 100% guarantee of a cheaper gold for local investors, but it is clearly often the case.

That's why if you want to buy gold, I would suggest you to wait for the Aussie gold price to correct. Currently these are the historical highs. If we have a look at the Aussie gold itself on a weekly chart (above), the MACD shows that the bullish momentum is likely to be over. It has peaked at unprecedented high levels on early January and has already started to curve downward.

Historically a similar configuration happened twice, in May 2006 and March 2008 (circled on the chart). If the MACD crosses below its signal line, it would be a clear signal of trend reversal, and would drive the Aussie Gold much cheaper. We will keep an eye on that in the coming weeks!

Gabriel Andre
for The Daily Reckoning Australia

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The government wants people to understand their money is safe in the banks. That's why that last bit is in there. It's designed to keep foreign holders of Aussie dollars from engaging in a run on the dollar and bringing their money home, wherever home might be (Japan, for example).

The Australian dollar is up in early trading. But its huge slide in just a few months is remarkable. It's good for exporters (especially farmers). Aussie agricultural goods now become relatively cheaper on foreign markets. It's not as good for consumers, who could see higher prices on imports (and there are a lot of imports in the consumer goods sector of the economy).

The big question, of course, is how shares will react to the weekend's events? So far so good. They're up 6% in early trading.

Polling the crowd this weekend and the Melbourne Investment Expo, we got the impression that there was a bit of capitulation on Friday. Investors who could not afford to lose anymore capital may have exited the market during the big 8.3% slide. Fear gave way to abject terror.

There may also be another reason-aside from the panic in the banking market-for Friday's frenzied selling. When Lehman Brothers was allowed to fail, it defaulted on some US$130 billion in senior debt. Against that debt, hedge funds and other Wall Street investment banks had sold some US$400 billion in credit default insurance.

Remember, anyone can sell credit default swap (CDS) insurance. It's a little like writing options. You collect the premium and hope you never have to pay out on the policy. So firms like Goldman Sachs (NYSE: GS), JP Morgan Chase (NYSE: JPM), and Morgan Stanley (NYSE: MS) sold huge amounts of credit insurance against default in Lehman bonds.

One theory making the rounds last week was that those investment banks and hedge funds were selling assets and hoarding cash in preparation for judgement day on how much of that insurance they would actually have pay out. An auction was held last week to determine the value of the outstanding Lehman CDS.

Based on the results of the auction, it looks like anyone who sold default insurance on Lehman bonds will have to pay out around 90.25 cents on the dollar to the holders of the CDS. Obviously, that could be a huge number, based on the gross value of the CDS outstanding ($360 billion). But if the banks and hedge funds have already hedged against their risk in writing these credit default swaps, it won't be any big deal.

If, on the other hand, you were a hedge fund selling CDS on Lehman's debt without making any provision that you'd actually have to pay up, well you, my friend, are in a sorry state. And you were probably selling assets like cheap underwear to raise cash last week. What does any of this have to do with the Aussie share market?

Blue chip Aussie mining shares like BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO) and OZ Minerals Limited (ASX: OZL) have been the darlings of hedge funds wanting to own commodity stocks. The Aussie dollar has also been a popular commodity currency and yield play. If hedge funds and investment banks were liquidating commodity positions to raise cash for the Lehman CDS auction, it would most likely hammer Australian stocks.

That's one reason Aussie stocks fell much harder on Friday than stocks on Wall Street. Australia has a high percentage of stocks that were attractive to leveraged speculators when commodity prices were high. Now, those assets have seen a large amount of selling. With the Lehman CDS auction behind us, will the selling end?

We'll see. Beyond Lehman, there are the larger issues in the global financial system. On that score, politicians in Europe raced against the opening of global markets this morning. They announced a package of reforms that would: guarantee interbank lending, guarantee debt issued by banks until 2009, give government's permission to buy preferred shares in banks, make provisions to directly recapitalise any banks that were deemed "systemically critical."

While the Euro nations try to unfreeze the banking sector by effectively guaranteeing all lending, regulators in the U.S. and the U.K. are taking similar steps. The British government will take controlling stakes in the Royal Bank of Scotland and HBOS Plc. The Brits have also decided to inject about A$125 billion in capital directly into the banking system.

We covered the big-picture implications of this policy response in yesterday's special Sunday edition of the Daily Reckoning. If you missed it, you can find it here (Australian Resource Shares, What's Next). But it's not hard to see what's going: government guarantees to all bank lending, and direct, unsecured government lending to anyone who asks for it.

Will putting more money (credit) into the hands of those who created the problem in the first place actually help? Probably not. As Jim Rogers told CNBC, it's setting the stage for an 'Inflationary Holocaust.' It's hard to believe at first that the current deflation in financial assets will give way to astonishing inflation. But that's just what we expect to happen.

Specifically, governments will boost lending to the private sector via central banks. You can also expect direct stimulus for households via rebate packages and tax breaks. In the long-run, big government spending programs on public works, infrastructure, and energy are a certain political winner.

And where will the money come from? Good question. It will be printed or borrowed into existence. Money supply will rise. And with the banking sector effectively nationalised, private investors will look for a real hedge against the inflation being unleashed.

We would take a strong look at over-sold Aussie oil stocks right now. Not only are they over-sold from a technical perspective, but the oil price has nearly halved from its highs earlier in the year. You may not get a better chance to buy them at this price.

Of course, if the market gets any worse than it got last week, it will no longer be the worst financial crisis since the Depression. It will be the worst financial crisis of modern times, full stop. If that is the case, it marks the end of one era and the beginning of another.

In the meantime, however, you could do worse than build a "Robinson Crusoe" portfolio. That is, when his ship ran aground and all his colleagues were lost at sea, Crusoe spent three days salvaging anything from his ship that would be of use in living on his deserted island. His misfortune was severe. But he had enough sense to realise the ship contained items that would be essential for his survival after the shock of his shipwreck.

The stock market offers you a similar opportunity, once the selling abates. You will get an excellent chance to buy Australia's best shares at very low prices.

Dan Denning
The Daily Reckoning Australia

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