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Monday, December 11, 2006

Is OPEC Turning Away from the Dollar?

There was an interesting story in Sunday's Financial Times...

Oil producers shun dollar

Oil producing countries have reduced their exposure to the dollar to the lowest level in two years and shifted oil income into euros, yen and sterling, according to new data from the Bank for International Settlements.
The revelation in the latest BIS quarterly review, published on Monday, confirms market speculation about a move out of dollars and could put new pressure on the ailing US currency.
Russia and the members of the Organisation of the Petroleum Exporting Countries, the oil cartel, cut their dollar holdings from 67 per cent in the first quarter to 65 per cent in the second.
Meanwhile, they increased their holdings of euros from 20 to 22 per cent, the BIS said. The speed of the shift may help to explain the weakness of the dollar, which recently fell to a 20-month low against the euro and a 14-year low against sterling.

XX My take: While this is worrisome, the big fear is that China will start to shift its massive foreign reserves out of the dollar. Indeed that's what the Chinese threatened to do on Thanksgiving, and China slowed purchases of Treasuries in the last two years even as its foreign exchange reserves surpassed $1 trillion, the largest in the world.

So how do we explain the rally the dollar is experiencing now? Well, the dollar suffered a major breakdown in November. Sentiment turned very bearish. It's only natural that we see some kind of short-term bounce under those conditions, and I think that's what we're seeing now, helped along by kind words from US Treasury Secretary Hank Paulson.

Kind words will only get you so far, though, as Al Capone famously once said. If historical trends hold true, the November sell-off will be followed by another, deeper sell-off toward the end of the year. Now, these things aren't written in stone -- it might be pushed out until January if Paulson has enough tricks up his sleeve. But it would be a good time to be long gold and silver when it comes.

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