Worried Investors Rush Back Into the US Dollar

We saw the return of some pretty good volatility in the currency and metals markets yesterday with the dollar rising sharply and commodities dropping. It was definitely a ‘risk off’ kind of day with almost every currency down versus the US dollar as investors, scared by the ongoing European sovereign debt problems and a slowdown in the Chinese economy, rushed into the US dollar which is still seen as a ‘safe haven’. Yes, in spite of all of the debt and deficit problems here in the US, the US Treasury market is still seen as a risk free environment and it is where large investors hide during uncertain times. The 10-year bond, which we track in the currency roundup below, was up over 60 basis points dropping the yield back down below 3.2%.

The selloff in both the equity markets and commodities was pretty dramatic and began with worries over Greek debt restructuring and were perpetuated by data that suggested the Asian markets are slowing down. I have reported on the events in Europe all week, so readers know the situation there. But what apparently sent investors running scared was the data released yesterday in Asia, which showed that industrial production growth in Malaysia and China is slowing as central banks there raise rates to quash inflation.

Asia continues to be the engine pushing global growth, and any sputter or misfire in China or the other Asian economies worries investors. But isn’t this exactly what all the economists wanted to see? I’ve read story after story over the past few years about how China was growing too fast, and how they need to let their currency rise in order to step on the brakes. Now we get news that their economies are in fact slowing, and investors get all worried! The key will be how much control the Asian governments can have in this slowdown. As long as it is orderly, the global economic impact will be minimal. The worries are that the measures taken by the Asian central banks will not be a tap on the brake pedal, but an all out mashing of the brakes to the floorboard.

Global investors have definitely tempered their optimism regarding the overall global growth. According to the quarterly Bloomberg Global Poll of investors, 1 in 3 plan on holding more cash over the next six months. That doesn’t bode well for the equity markets, but could be good news for the currency markets (depends on which ‘cash’ these investors plan on holding). But for most of these investors, cash means US Treasuries. With all of the global uncertainty, you would think the precious metals would be another place these investors would be looking to ride out the storm, but 30% said they intend to reduce investments in commodities. Chuck gave his last presentation in Las Vegas yesterday, and sent me this note last night regarding the gold and silver markets:

I gave me third and final presentation on Wednesday, and talked about gold and silver… Now many of you know that I truly believe that there was some hanky panky going on last week, and probably again yesterday, with the silver price, what with the three margin requirement increases in a week, and all the after hours trading in silver… And I told the audience just that! I did point out that when an asset like silver has such a quick rise, and the “correction” sets in, that there would be a steep drop in the price, then a short rebound, and then a return to the drop in price… Much like we’ve seen so far in silver! That means that silver could very well drop below $30 on this next go-around in selling… But, as I told the audience, any price below $30 represents a buying opportunity to me! Of course, that’s just my opinion, and I could be wrong, but that’s my thought…

Another thing came up yesterday regarding something Chris wrote about the next reserve currency being SDR’s (Special Drawing Rights)… It was in contrast to what I had just given a presentation on regarding the steps that China was making to place the renminbi (CNY) as the next reserve currency of the world… The person wanted to know why we differed in our thoughts… Look folks, the key here is not what replaces the dollar as the reserve currency of the world… It’s the fact that… THE DOLLAR WOULD NO LONGER BE THE RESERVE CURRENCY OF THE WORLD! Our costs would rise, our interest rate on the loans we get would rise, the price of commodities would rise… (Ready for $10 gas, like they have in the UK, where they no longer have the reserve currency of the world?) And yours, mine, and the guy’s down the street who washes his car with his shirt off, purchasing power would go to hell in a hand bag… That’s… The important thing!

Chuck and I almost always agree on the long-term trends, and another guy who we both usually agree with is Jim Rogers. I was nodding my head yesterday as I read a story on Bloomberg quoting Rogers who said the US dollar is going to be a ‘total disaster’ in the long term. Rogers, like Chuck and I, worries that the US position as the world’s largest debtor and the policies being pursued by Federal Reserve Chairman Ben Bernanke will lead to a dramatic devaluation of the US dollar. “The situation is getting worse and I expect to see severe problems in the US,” Rogers said today. “Dr. Bernanke doesn’t understand economics, he doesn’t understand finance, he only understands printing money and we can’t quadruple the amount of money in the next slowdown.” According to Rogers, the Chinese renminbi should be seen as the ‘safe’ currency instead of the US dollar, but he is currently buying dollars because the consensus in the markets is for it to fall. Rogers, who was one of the first to call the commodity bull market, said he couldn’t forecast when the current bull market would end. “I expect to see more currency turmoil maybe this fall, and more turmoil by 2013”, said Rogers. There is good profit to be made during times of turmoil!

The data released in the US yesterday showed that the US trade deficit widened, while our budget deficit narrowed slightly in April. Neither was much of a surprise, as the rise in the price of oil caused the trade deficit to widen while an increase in tax revenues narrowed the budget deficit. Today we will see the weekly jobs numbers which are expected to show that another 430K applied for unemployment last week. We will also see the first ‘official’ view of inflation during April with the release of the PPI data. The producer prices are expected to have risen 6.5% YOY during April, but the boys and girls over at the Fed continue to turn a blind eye to these price increases. We will also see retail sales and business inventories in the US, which are both expected to have risen slightly.

Data out of Europe this morning furthered investor’s concerns, as European industrial production unexpectedly declined in March. Production slipped 0.2% from February when it climbed 0.6%. Economists had predicted a 0.3% gain. But the biggest news out of Europe this morning wasn’t the drop in Industrial production, but the German Chancellor Angela Merkel’s backing of Italy’s Mario Draghi as the next president of the ECB. Merkel’s backing is important, as the ECB is really just a mirror of Germany’s Bundesbank. Germany is Europe’s largest economy, and their influence over the monetary policies of the ECB is dramatic. I think the markets would be a bit worried with having an Italian taking the reins of one of the world’s most influential central banks, so having the German leader’s stamp of approval is important.

Norway will release their interest rate decision this morning, and many expect them to raise their benchmark interest rate by another quarter point. This would be the first raise in a year and would give investors another reason to buy the krone  (NOK) (like investors really need another reason!). Norges Bank governor Øystein Olsen is trying to steer his economy away from rising prices. Norway has Europe’s lowest jobless rate, and with oil over $100 a barrel prices have been rising. Policymakers signaled in March that they would be raising rates in either May or June in order to combat inflation. We will see today which of these months it will be. No matter what happens to interest rates in Norway today, the Norwegian krone will continue to be one of the currencies every investor needs to have in their portfolio. The economic fundamentals of Norway make it, in my opinion, one of the true ‘safe havens’ of the currency markets.

The drop in commodity prices and the ‘risk off’ attitude of investors hit the South African rand (ZAR) and Brazilian real (BRL) pretty hard yesterday. The rand weakened for a third day, and is now down over 3% versus the US dollar in the past week. South Africa’s currency is the worst performer, as speculation increased that the Reserve Bank of South Africa will keep interest rates on hold tomorrow. Manufacturing growth has slowed in March and consumer prices are not rising as fast as in other parts of the globe. The $10 drop in the price of crude oil has pushed the Canadian dollar (CAD) lower overnight. The loonie had been on a 3-day run higher versus the US dollar, but the dramatic move in oil prices ended this week’s rally. The recent elections have given the Canadian government the courage to make the cuts necessary to bring the deficits under control. As long as they carry out these cuts, the Canadian currency should continue to outperform the US dollar.

The Australian dollar (AUD) fell yesterday on weaker employment data and a fall in commodity prices. Unemployment increased in several areas of Australia, and a reported slowdown of the Chinese economy also weighed on the currency. China is the largest importer of Australian raw materials, so any slowdown of the Chinese economy will certainly have subsequent impacts on the Australian economy. I for one, believe the Chinese economic slowdown will be controlled, and the commodities will continue to be well bid. Both of these are good news for Australia, which remains as one of the ‘pick’ currencies on the desk.

To recap: It was a ‘risk off’ day yesterday with investors rushing out of equities and commodities and running back into US treasuries. Worries over the European debt restructuring and a Chinese slowdown were the main drivers of this investor fear. Chuck gave his opinions on the latest precious metals sell off, and Jim Rogers agrees that the US dollar is in trouble over the long term. Data shows Europe’s recovery is slowing, and Norway is expected to raise rates. Finally, the drop in commodity prices has caused a selloff in the commodity currencies of Canada and Australia.

Chris Gaffney
for The Daily Reckoning