Murphy''s ''Midas'' commentary for Sept. 21 posted in the clear at GoldSeek


By Natsuko Waki
Wednesday, September 21, 2005

LONDON -- The dollar's share in global currency reserves is
steadying after a dip following the euro's birth in 1999 but inflows
from emerging economies are still supporting the single currency.

Data from the International Monetary Fund (IMF) released over the
past week showed the dollar's share of official reserve holdings in
2004 stabilised at 65.9 percent in 2004 after falling from a 1999
peak above 70 percent.

Analysts say this reflects the slowing pace of reserve
diversification among central banks, as well as a sharp rise in
Japan's reserve holdings -- largely dollar-denominated and the
world's biggest.

But continuing diversification flows from central banks in emerging
nations, who are receiving large dollar receipts via intervention or
oil revenues, are likely to underpin the euro.

"If you consider Japan has the biggest component of (global
reserves) the data is skewed toward Japan. If we were to strip out
Japan there would be a far stronger reserve diversification story
going on," said Adam Myers, currency strategist at UBS.

"Developing countries series are a pretty good leading indicator in
what's going on behind the scene. The theme of dollar
diversification is still in play and will remain throughout next

Central banks, which hold around $3.7 trillion worth of reserves,
are an increasingly important sector in the $1.9 trillion-a-day
currency trading market.

Speculation that official money is flowing from the dollar into the
euro was partly behind the greenback's tumble to record lows against
the euro in 2004.

However Japan, whose reserves rose $170 billion to $840 billion over
the past year, has been buying dollar assets and has repeatedly said
it will not diversify.

"Developed market nations, predominantly Japan, have practically 100
percent of their FX reserves in dollars. That skews the (IMF)
weighting in favor of the dollar," said Steven Pearson, chief
currency strategist at HBOS Treasury Services.

The dollar hit record lows of $1.3667 per euro in the final days of
December 2004 on diversification speculation. It has recovered since
on expectations of steady rises in U.S. interest rates, and was
trading around $1.2223 on Wednesday.

Pearson said stock diversification, whereby reserve managers change
the currency composition of their portfolio to make it more
balanced, has largely finished after countries such as China sold

HBOS estimates China has already cut dollar holdings to 60 percent
from 90 percent in 2002, while dollar weightings of South Korean and
Taiwanese reserves have fallen to 55 percent from above 60 in mid-

Pearson says flow diversification, where central banks sell some of
the dollars accumulated via intervention operations or oil receipts
to preserve the composition they have, is going on.

"Flow diversification ... is continuing although at a much slower,
muted pace," he said.

"The place we are seeing the most aggressive flow diversification is
from oil-producing nations who are accumulating dollars quite
quickly and therefore have to take immediate action if they don't
want to end up with nearly 100 percent in dollars."

Central banks from oil-rich nations including Russia are likely to
have accumulated the large sum of dollar revenues as crude oil
prices have more than doubled since early 2003 to a record high at
over $70 a barrel late in August.

Reserve diversification involves not just changing the currency mix
but also shifting across different types of asset classes -- a
process that could benefit the dollar.

Japan has said it is taking a more active management approach and
buying and selling securities in the secondary market rather than
purchasing new issues and holding until maturity.

"As central banks move up the risk-return curve, they could hold
agency or other quasi-government papers as well as corporate
bonds. ... Riskier assets are much more liquid in the U.S. than
anywhere else," Stephen Jen, chief currency strategist at Morgan
Stanley, said in a note to clients.

The bank's analysis shows the U.S. corporate bond market accounts
for 57 percent of the global market capitalization in the countries
sampled, 3-3.5 times bigger than in the euro zone or Japan.

The market capitalization of the U.S. equity market accounts for 47
percent of the total market capitalization in the sample, 2.5-3
times bigger than the markets in the euro zone or Japan.

"This means from a liquidity perspective, as central banks diversify
across assets, there is greater justification to increase their
exposure to dollar-risk assets," Jen said.

"These flows may one day be as large as the flows out of dollars."


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