Let’s see if we understand yesterday’s earth-rumbling response to China’s 25 basis-point increase in a yuan lending rate. For starters, the dollar had its biggest one-day rally since August (which rally went nowhere, to remind you; the dollar wafted slightly higher, then scuddled sideways for nearly a month before resuming its long-term bear market). Another effect of China’s decidedly un-momentous change, which supposedly was aimed at damping real estate speculation and inflation, was that bullion had its worst day in recent memory.  Comex Gold and Silver futures contracts were down nearly three percent, and there was little evidence at the bell that bullion’s inevitable rebound was immediately imminent. And, finally, we saw the heaviest selling of equity shares in more than two months, with the Dow Industrials down 226 points at their intraday lows.

Does all of this mean anything?  In a word, no. China’s modest rate hike did not change any global paradigms, and gold and silver most assuredly are not anticipating a shift toward austerity by those drunken sailors of our economic lives, the central banks.  As for the dollar, there was talk that its big rally represented the flight of capital into the safe haven of cash.  But if that is so, why did that other horrifically overrated “safe haven” – i.e., U.S. Treasury bonds – not come along for the ride?  December T-Bond futures were in fact up a whopping nine ticks, reflecting no appreciable surge in fear, nor any increase in the demand for “safety,” even when attached to a nominal yield.

Shouldn’t Dollar Have Fallen?

One is tempted to say the whole investment world got it wrong yesterday, and that the dollar should logically have fallen on news of an increase in Chinese lending rates.  That the greenback moved the “wrong” way is akin to the wild conniptions that Treasury bonds trace out whenever some wholly fabricated, miserably worthless statistic like the payroll number hits the tape. Usually, the initial price stab is reflexively opposite whatever mini-trend existed moments prior to the announcement, and it typically takes two or three more wild counter-swings to orient the bonds in a direction that can somehow be rationalized as logical, based on the news. And so it was yesterday with the dollar, except that, instead of “getting square” with the news by day’s end, the dollar will instead experience second and third thoughts in the days ahead. A delayed reaction, in other words. And because nearly all dollar hedges these days are carry trades built on short-dollar strategies, we shouldn’t be too surprised if the short-squeezy swings continue to be pretty wild.

Meanwhile, what helped to greatly exaggerate price movement in numerous markets yesterday is the fact that “something” – i.e., a hitherto obscure and inconsequential Chinese lending rate -- had changed. Traders seized upon this stimulus-from-out-of-the-blue with the headless-chicken demeanor that gives the markets their entertainment value.  With China making it more costly to borrow the yuan, the traders must have asked themselves, shouldn’t we react to this – and react in a BIG way, since we haven’t heard news of this sort in who-knows-how-long?  And so, they reacted – wildly. Shamelessly.  Idiotically. But we should not allow yesterday’s mindless spasms to taint or even color our thoughts on gold and silver, which remain in a powerful, long-term bull market; or our thoughts on the dollar, which at this point is capable only of an occasional death rattle as it settles into its grave.

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-- Posted Wednesday, 20 October 2010 | Digg This Article