Big Trouble for the US Dollar?

Hyperboles are nothing new to gold bugs. One of my favourites was a description of the coming Islamic Gold Dinar describing it as a neutron bomb against the US Dollar, worse than anything than Osama Bin Laden could possibly do. While that may be an overstatement there is a potential for the Islamic Dinar to cause severe dislocations.

The reasons behind the Islamic Gold Dinar are simple. Gold cannot be inflated, nor can it be devalued, nor is it dependent on anybody's promise to pay. Gold is no one else's liability. Paper assets - currencies, stocks, bonds, and bank deposits are merely promises to pay something that is borrowed. Currencies collapse, stocks can go to zero, bonds default and banks close their doors. All of these are constants in today's world of paper assets somewhere in the world. And the Western Nations especially the US are built on a mountain of paper assets where over the past few years it has taken almost $7 in new debt to purchase $1 of GDP even as the paper assets in the stock market are inflating once again and the US$ is falling.

The Islamic Gold Dinar has been in the works now for a number of years. It is used in a number of Islamic countries already but thus far its use remains small. It could soon be gaining wider usage as it is being promoted widely for Muslims to exchange their paper currency for the Islamic Gold Dinar. There are a number of Dubai-based mints and mints in other Islamic countries producing gold dinars as well as silver dinars. Malaysia adopted the currency in mid-2003 and a number of other Islamic countries are slated to join this year. It is the intention of the Islamic countries to use the Islamic Gold Dinar to replace the US Dollar for commercial transactions between their countries.

There has even been an electronic dinar website started at www.e-dinar.com. The member countries of the Islamic Development Bank (some 51 countries) are committed to moving to the use of the Islamic Gold Dinar as a medium of exchange. The Islamic Dinar is equivalent in value to the IMF's Special Drawing Rights (SDR's) which is the unit currency of IMF and itself is backed by gold. There is also an agency in Dubai set up to handle accounts and payments between accounts. This is meant to allow the use to spread further throughout the Muslim world.

While there has been considerable press about the Islamic Dinar in Muslim countries it has caught little attention in the Western nations. That is probably because thus far it has not had much impact. But as gold continues to go higher and the US Dollar falls further that may change. We are reminded that while Gold and Silver are commodities they are also monetary assets.

While the potential for the growing use of the Islamic Gold Dinar will add to the monetary demand for gold (and silver) there is another potential monetary demand looming. That is China where the Chinese government in 2002 revived the long dormant (for 50 years) Shanghai Gold Exchange and also authorized the Bank of China and the commercial banks to trade in gold. Under the previous communist regime there was a long period of condemnation of gold.

In 2004 the people of China will be allowed to buy gold for the first time as an investment since 1949. This could be significant as for the past two years the Chinese government has been laying the groundwork. There is estimated to be upwards of US$1.3 trillion in savings currently in the Chinese banking system. These savings have helped fuel China's incredible growth but now being free to buy gold for the first time in years if even a small amount say 1% it would put pressure on the gold market to fill demands.

As well the Chinese have been openly concerned about maintaining the value of the Yuan given a long history of currency collapses. The Bank of China has been a significant purchaser of gold during the period when the announcements always seemed to be favouring that central banks were selling gold. As well the Bank of China has been a significant purchaser of US securities in order to help maintain the value of the Yuan against the US$. As a result China's foreign reserves have been growing and they want to maintain at least minimal levels of gold (2.4%) as a portion of their reserves. The Chinese are also very interested in the Islamic Gold Dinar and the possibility of backing the Yuan with gold. This could set the stage for Asian countries to be gold based in an era that the Western Nations maintain a fiat currency system.

We believe that the gold movements in the Islamic countries and China are largely being ignored in the Western nations because it has not as yet become significant. But the day of reckoning may be looming closer as the potential for a huge surge in demand from 1.3 billion Chinese and another 1.5 billion Muslims begins to take hold. India is already the world's largest consumer of Gold and if we add the potential in the Islamic countries plus China there would be two further demands for gold (and silver). One demand would be in the traditional commodity sense for jewellery and the other for monetary purposes in an area of the world that holds over half the world's population. None of this would be positive for the US$ currently the world's reserve currency.

The current weakness in gold (silver) is being driven by the desire of the Europeans and the Japanese to slow the advance of their currencies against the US$. This is temporary as each of them are in a race to the bottom in currency devaluation. But this correction is one that could last into the second quarter 2004. We have targets of at least $400 on Gold and possibly as low as $390 so investors may wish to be patient before jumping back into the gold market.

Investors are reminded that still the best way to purchase bullion is by owning either of Central Fund of Canada (CEF.A-TSX) (www.centralfund.com, 905-648-7878) a closed end trust, and the Millennium BullionFund (www.bullioonfund.com, 416-777-6691) (Note: I am a director of the MBF) an open ended mutual fund trust. Central Fund can trade at a substantial discount or premium to NAV depending upon demand.

The current pause in gold and silver prices as well as other commodity prices is also an opportunity to mine for junior exploration plays. These small companies exploring for minerals in the outer regions of the world are important in the process. The world is facing shortages of many commodities as demand world wide increases particularly from Asia. It takes upwards of 12 years to go from exploration to a working mine so these juniors are at the forefront.

We have mentioned some junior mining plays in other articles. We believe these companies are at the cusp of a significant boom in 2004. There are many of them out there almost too numerous to mention. Like the major producers they are currently correcting their first good move up seen in late 2003. So this is a time to accumulate while the prices are still low. Three more that we are following are: MacMillan Gold Corp. (MMG-TSXV) (www.macmillangold.com, 416-867-1101) with properties in Mexico in gold and silver; Spider Resources Inc. (SPQ-TSXV) (www.spiderresources.com, 416-815-8666) a company with projects in Ontario, Brazil and the Northwest Territories involved in base metals and diamonds; and, Canadian Golden Dragon Resources (CGG-TSXV) (www.goldendragon.com, 416-504-0077) with exploration in Ontario and Quebec.

Charts and technical commentary by David Chapman of Union Securities Ltd. 69 Yonge Street, Suite 600, Toronto, Ontario, M5E 1K3 (416) 604-0533, (416) 604-0557 (fax) 1-888-298-7405 (toll free) email [email protected]

David Chapman is a director of the Millennium Bullion Fund

The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. Neither David Chapman nor Union Securities Ltd. take responsibility for errors or omissions which may be contained therein, nor accept responsibility for losses arising from any use or reliance on this report or its contents. Neither the information nor any opinion expressed constitutes a solicitation for the sale or purchase of securities. Union Securities Ltd. may act as a financial advisor and/or underwriter for certain of the corporations mentioned and may receive remuneration from them. David Chapman and Union Securities Ltd. and its respective officers or directors may acquire from time to time the securities mentioned herein as principal or agent. Union Securities Ltd. is an independent investment dealer and is a member of the Toronto Stock Exchange, the Canadian Venture Exchange, the Investment Dealers Association and the Canadian Investor Protection Fund.