The Dollar Bounce
As far as everyone is concerned, the long-term outlook for the dollar spells disaster, as Dr. Richebächer showed us in this space yesterday. But for the short-term, Doug Casey isn’t convinced that the dollar will do what everyone thinks it will…he says it may actually rally!
Especially since the IS of Nov 2000, which was devoted almost entirely to the pending collapse of the U.S. dollar, we’ve spent a lot of time here explaining why the dollar is in such trouble. In the period from its peak in February 2002 to the time of this writing, the dollar has lost 57% against the euro, 75% against the NZ$, and 112% against the chronically pathetic South African Rand. It’s down 25% from its peak against Turkish lira, which suffered 20% domestic inflation last year, leading the government to make a decision to knock 6 zeros off its banknotes. The U.S. dollar has even lost 124% against the latest incarnation of the Argentine peso, traditionally one of the world’s strongest competitors for the toilet paper of currencies.
But now, not despite the dollar being all over the world’s media as a disaster, but because of it, it’s probably time for a bear market rally. By definition, the masses are trend followers, not contrarians. Regardless of what the long-term fundamentals of a currency may be, in the short term its price is set by the psychology of buyers and sellers. Right now everyone knows how badly it’s done, and they’re all sellers. As I write, the euro has hit a new all-time high of $1.36 against the dollar.
Everyone and their dogs have finally become aware of the dollar’s problems. Therefore, I suspect that it’s almost time for Business Week to run a cover story projecting the death of the dollar, ringing the bell for a temporary bottom. But the dollar is still (for the moment) the world’s currency. The recent anti-dollar hysteria will wear off and sellers will buy back a lot of dollars, simply because the dollar is still, for all its faults, a liquid and convenient holding.
A rebound, however temporary, in the U.S. dollar will be helped along by the U.S. Government (USG) which, wanting to forestall the inevitable, is taking action to shore up the dollar by raising interest rates, making it a more desirable holding. I wouldn’t be at all surprised to see the unit stabilize, or gain 10-15% over the next two or three months.
The prospect of dollar strength is almost certainly bearish for gold, because so far the strength in gold has been as much a mirror image of the dollar’s weakness as anything else.
The Dollar’s Problems: Two Big Positives
Within that statement, however, are two big positives for readers of this publication:
First, the strong correlation between the U.S. dollar and gold over the last few years confirms that there is a significant subset of the world’s financial community that now, correctly, views gold as a global currency. Foreigners know that their own currencies are little better fundamentally than the dollar – they’re just pieces of paper that are temporarily strong against the dollar. The eurozone countries have all the problems of the U.S. dollar (like bankrupt national pension plans) and more, stemming from an even more socialistic approach to problems. At least, perversely, the USG can ultimately support the value of its currency by taxing Americans: with the implementation of the European Union, and considering already high tax burdens across the eurozone, Brussels can’t steal the assets of Europeans nearly as easily.
The cycle that is unfolding is, at this point, fairly predictable. Namely that the sheer volume of negative attention paid to the intrinsic flaws of the U.S. dollar will lead, in a natural progression, to a comparison with competing currencies, the euro and gold in particular. At that point people will increasingly begin turning to gold (and electronic forms of same) to preserve purchasing power.
This is not going to happen overnight, but it is going to happen. In the meantime, I expect the U.S. dollar to stage a rally.
The second positive is that the gold stocks will move down as the dollar rallies, providing us with what I would consider a last-train-out chance to load up our portfolios with the best of the best. Does that mean that we should now sell, in anticipation of such a downturn? My inclination is, other than normal house cleaning and profit taking, no. Far too often, once a stock is sold it is forgotten… until you read about it taking off to the moon without being on board. In addition, provided you own stock in quality companies – well-run, financially sound operations with big projects – a dip in the stock shouldn’t be concerning at all.
As you’ll see in the quarterly company reviews that make up the majority of this edition, there are a lot of very attractive companies to pick from, but given my view on the short-term outlook for the U.S. dollar, you may want to be a bit cautious to adding to positions over the next month.
Despite my contrarian instinct that gold might have a rough month or two, nothing is changed about my mid- to long-term views on gold (it’s going to the moon) or the U.S. dollar (it’s going down the drain).
The Dollar’s Problems: How the World Sees the Dollar
In support of that outlook, I need only take a quick look at the global perception of the U.S. dollar.
Take the OPEC countries. They certainly have no incentive to either own the dollar or keep assets in the U.S. If I were them, I’d be very afraid that the USG might hold my U.S. assets hostage in the so-called War on Terror, wherein all Muslims (correctly) see themselves as the enemy of choice.
That’s one reason why OPEC reports show that its member nations have cut their holdings of dollars from 75% to 61% of deposits in the last three years. It’s true that Arab FX reserves are small, totaling only about $65 billion for Saudi Arabia, Kuwait, Qatar, and the UAE – a mere tenth of the Chinese reserves, for example. And I doubt they’ll ever grow much beyond that, simply because practically every economy in the OPEC is chronically corrupt and socialistic. But as OPEC countries move away from the dollar, the world will see it as one more straw in the wind. That’s on top of the gold-backed dinar, created by Malaysia, which I expect will gain favor.
Even should I be right in believing the euro will ultimately share the same fate as the dollar, I am of the opinion that OPEC member nations are going to begin pricing their oil, and hold larger percentages of their currency assets, in euros, not dollars… if only because Europe is a much bigger trading partner for them than the U.S. OPEC imports from Europe rose 29% between 2001 and 2003, while those from the U.S. fell by 14%. The way I see it, that trend is likely to accelerate (unless the collapse of the dollar prices U.S. goods at giveaway levels), mainly because the Europeans haven’t positioned themselves as enemies.
Moving to the East, we are beginning to see the Chinese, (soon to be followed by other big potential bag-holders of U.S. dollars) divest themselves of their U.S. dollar positions by trading for real assets. IBM has just sold its laptop division to a Chinese company for $1.3 billion, and the Chinese are bargaining to acquire Noranda in Canada. No doubt they’ll be spending scores of billions in the U.S. on capital assets in the near future, while Americans are spending hundreds of billions on worthless trinkets from the Chinese. It’s almost as if the Chinese will be doing to Americans what Americans did to the Indians when they bought Manhattan. It never makes economic sense to trade capital goods for consumer goods. And, unlike the Japanese, who managed to shoot themselves in the foot by top-ticking every market they entered in the late ’80s, I suspect the Chinese will be shrewd buyers. The only thing stopping them is that they’re probably afraid, like the Muslims, that the USG could go psychotic and freeze their assets on some pretense.
While the Japanese Central Bank has recently been making noise about redoubling its efforts to support the U.S. dollar, it is increasingly helpless to do much about it. They simply don’t have enough money to keep the floating abstraction of the dollar afloat.
How will all of this end up? As nationalistic and paranoid as the United States has become, it’s entirely possible that the government might do something irrational in the military or economic arenas, where it is most powerful. Militarily, I expect it to continue the present trend of pointless adventurism. That’s an easy call.
Economically, however, I suspect we’ll see a reversal of what has been a longstanding trend towards freer trade and freer markets. As the USG sees capital leaving the U.S. and the world dumping dollars, it’s not going to solve the problem by controlling itself – which is the only, and ultimate, solution to the problem. What they’re going to do (and I recognize this is a radical prediction) is put capital and FX controls in place. We have already seen attempts by Bush to erect trade barriers; capital and FX controls are just points further up the continuum. Of course they will be completely counter-productive. Disastrous. But desperate men with power do desperate things.
The bottom line? Although I think the dollar is in for an upward bounce, the long-term downtrend is still very much intact. You should continue to buy gold and other commodities, especially on weakness. And get as many assets as possible outside of the United States now, while you still can. In that regard, in the months to come I’ll draw your attention to well-positioned international real estate investments.
for The Daily Reckoning
January 05, 2005
Editor’s Note: Doug Casey, Chairman of Casey Research, LLC is one of the world’s most respected authorities on investing in natural resource stocks and editor of the International Speculator, now in its 27th year.
Today, at noon, London will fall silent again. For three minutes, all of Europe will keep quiet in honor of the 150,000 people killed by the “Death Wave.”
Since the New Year has barely begun…we are still in a reflective mood. We wonder what it all means…
Why should we care what happens on Wall Street today, when so many bodies lie rotting in the tropical sun? We have been trying to come to grips with the scale and balance of things. More people die from AIDS in Africa each year, says a colleague. Nobody gets too excited about that…
And that’s the point of having money, anyway…so you can vacation in Thailand in the winter!
In Britain, the papers have all gone a bit gaga, in their typical mad and reckless way. Did the Americans give too little aid, too late? Was the White House stingy? And here come the celebrities, opening their wallets and their mouths! But where was Tony Blair? They ask how could the British Prime Minister could take a vacation at a time like this …as if he should fly to the beaches of Thailand, blow the breath of life into putrid lungs himself, and bring the dead back to life!
But that is what the media does – turn the sorrow of millions into a public spectacle.
But money is our beat…and we will stick with it. There’s nothing particularly amusing about a real tidal wave…
But, oh, a tidal wave of debt – that’s another matter!
We have been writing about the Great Mystery – why do bonds not sell off, as the dollar falls?
The underlying reason, we think, is that the world is headed into deflation – a credit contraction – that will help hold up prices on solid, fixed-return securities. Commodities are low already. Gold is correcting – down to $429. The economy is still not creating many new jobs. And TIPS, the inflation-adjusted 10-year securities offered by the government, trade at a narrow premium over regular 10-year notes; if there is inflation ahead, the bond market still doesn’t see it.
But there’s also a more immediate explanation: The foreigners are still buying U.S. bonds. Each day, nearly $2 billion worth of U.S. current account deficit flows out of the United States – which must be absorbed by foreigners and somehow make its way back to the United States to balance the books. But each day, according to figures provided by Stephen Roach, foreign central banks, chiefly, buy more than $2 billion worth of U.S. securities. This is what keeps the dollar from collapsing altogether. It is also why U.S. bond yields remain low, and why Americans are able to continue borrowing at such low rates.
Macro-economists, such as Roach, wait for the current account deficit to correct. One nation cannot live for long at another nation’s expense, they point out. But the United States continued its jolly, parasitical spending in 2005, at an even faster pace than 2004. A drop in the dollar seemed to have little effect. As long as the foreign central bankers continue to buy U.S. bonds, the good times will roll on.
But there’s another way to correct the imbalance in the world’s current accounts. A slump, a slow-down, a recession in America would reduce consumer spending. Instead of borrowing and spending, people would cut back. They might even save. The dollar might fall a little…or a lot. But what would correct America’s current account deficit would be a huge fall-off in demand. Instead of buying things they don’t need with money they haven’t got, Americans would begin holding onto the money they do have…and leaving the things they don’t need on Wal-Mart’s shelves and China’s loading docks.
Foreign investors will need higher real yields to continue buying U.S. dollar securities, says Roach. But they might get them in an unexpected way – by falling rates of price inflation…just as in Japan. Deflation is rare…and strange. As prices fall, real rates of return on savings go up. Buyers hesitate; if they wait to make a purchase, their money will be more valuable…and the price of the thing they are buying will be lower. The slump gets worse… Then businesses go broke. Jobs are lost. People at the margin can no longer make their mortgage payments. House prices drop. Stocks collapse. Look out!
We are just guessing, of course, that a tidal wave of debt is headed our way in 2005. The year ahead will tell its own tale in its own good time…and maybe we will be wrong…but we would stay off the beach anyway
[Ed. Note: Need help figuring it all out? Come to our World Money Show, which is being held in Orlando this year from February 2-5. And as a special treat, our very own editor-in-chief, Addison Wiggin will be mediating for a panel of top investment minds, all bent on uncovering the major new investment trends of 2005.
More news, from our team at The Rude Awakening:
Tom Dyson, reporting from Baltimore…
“But markets are fickle creatures…and even though the dollar’s exchange rate is moving lower just as we said it would, we must never stop questioning our position. We’ve made good money buying gold and shorting dollars recently but a sudden trend change could wipe it all away. Mr. Market delights in punishing complacency.”
Bill Bonner, back in London:
*** The issuance of junk bonds hit a new record in ’04, says today’s news. Loans to marginal borrowers, denominated in a slippery currency, sold on to people who people who have no idea what they’re getting into, at some of the lowest yields in history…giving them almost no margin of safety.
So much of what goes on in the world is humbug, fraud and poppycock, we recall saying the other day. The buyers of these junk bonds use historical data to justify their decisions. But the data was collected over many years when many fewer bonds were sold…from healthier borrowers…in a credit expansion (not at the beginning of a credit contraction) …at a time when the dollar was still a strong currency…and when junk bond buyers required much higher yields to make up for the risk!
*** A Canadian reader asks a tough question:
“I am a regular reader of the Daily Reckoning, and I especially appreciate the moral perspective that your essays bring to the often dehumanized topics of global finance and macroeconomics. A belief in the possibility of something for nothing, whatever its guise, is at root an immoral belief that disregards the concepts of real value added and wealth creation.
Sadly, such beliefs are today widespread, as Western asset markets rise in the face of steadily decreasing productive capacity and steadily increasing consumer appetites. Kudos to Bill Bonner for drawing attention this dynamic, and for placing it in a moral context.
“I write you today with a moral, and somewhat personal, question. I read with interest in your Christmas Eve essay, “Over the Top”, your humble protestations that Agora Inc. (if that is the parent entity of the Daily Reckoning) did not make the extraordinary amount of money that was apparently the subject of marketplace rumors. It reminded me of a thought that has often occurred to me as I have enjoyed previous DR missives: I wonder just how Agora earns its money, and how the firm would hold up if Bill Bonner’s moral lens were turned on itself and applied to his own operation.
“As you so often phrase it, does Agora get what it deserves, or does it get what it wants through feeding at the same trough of limitless liquidity as the reckless lenders and speculators it so often criticizes?
“Some clues are available. For example, while enjoying your daily email, I am often interrupted by advertisements proposing to sell me trading systems and ideas that will deliver “jumper stocks” and triple-digit returns in days. In DR emails, notice has been given that you are looking to recruit individuals with trading experience, suggesting that Agora likely trades its own capital as well. And of
course there is Bonner and Wiggin’s wonderful book, which I bought and read last year.
“None of this should be surprising to anyone, I suppose. Agora’s revenue comes from a mixture of proprietary trading, advertising, book publishing, and possibly subscription newsletters or portfolio management. It is natural that Agora would be first and foremost a creature of the financial markets and publishing. The DR newsletter must be funded, and Agora clearly has skills that are highly marketable in the investment world.
“The indelicate question I would like to pose is this: How does earning money through short-term trading schemes fit into your moral universe? You wisely admit to being unable to predict the near future, but claim to have a good idea of how things should eventually resolve in the long-term. Where do the speculators (even contrarian speculators!) who advertise in your emails fit into this ideal long-term resolution?
If you are in some way a profiting participant in the financial folly you lament, what do you deserve, dear editors?
“I do not want to question the integrity of the DR newsletter. It brings a very valuable perspective, I read it free almost every day, and I imagine I would love to work at a place such as Agora Inc. I pose this question only because I think your response would help me understand my own productivity, and how, if it is a conceit to believe a nation can earn money by thinking while the rest of the world sweats, any individual can rationalize in moral terms
being no more than a thinker.”
Dear Canadian reader:
Here at the Daily Reckoning our only virtue is our humility. But we have so much of it we are sure that it makes us superior in almost every way.
Well, this extreme self-deprecation leads to an always interesting and occasionally lucrative business philosophy: since we don’t know what will work…we’re perfectly happy to offer customers the advice and information and opinions that they actually want.
The editors of the Daily Reckoning, for example, do not trade options…or currency futures…or stocks…or baseball cards. We can walk through the lobby of the Venetian in Las Vegas with no desire to pull a single lever. (We have other weaknesses…in abundance.)
But we’re not fool enough to think we have the answers to all the world’s problems…or the magic formulas to wealth. We have, in fact, only our own ideas and opinions…which we offer to you, unvarnished, and we might add – for free – every day. You may take them or leave them. Or, you may wish to try the advice and opinions of others. We have been in this business for more than a quarter of a century. We have met many, many investors with many, many different approaches to making money – options, trend following, currency hedges, IPOs, insider trading information, technical systems, charts or astrology. As near as we can tell, none of them work particularly well forever…but all of them seem to work from time to time. We recall our old friend Mark Hulbert telling us that the one of the best investment records he had ever seen was made by a service that relied on the stars for its trading signals. In another period, a top performer was one where the editor never seemed to make a trade; he merely left his followers in T-bonds. We don’t know which approach will work or when it will work…but we are pleased to be able to let readers find out for themselves.
You may want to think of us as book publishers (which, in fact we are). We don’t claim to know which author has the ULTIMATE TRUTH; as far as we know each of them might have a little part of it.
Our personal point of view is on display here in the Daily Reckoning every day. We are neither investors, gamblers, speculators, analysts, nor economists…but moral philosophers, merely trying to figure out how the pieces fit together…and wondering if the knee-bone really is connected to the thighbone. We make no pretense of trying to make you wealthy, dear reader. Our only hope is that we all leave these daily reckonings no poorer…perhaps a little wiser…and much humbler.