The Dollar, Markets and Gold

Posted by Ray on August 11, 2009 under Economy, Markets | Be the First to Comment

We have had a nice rally in the dollar which has cooled a bit today, but it should have spelled disaster for gold, but it did not. A higher dollar also means equities are under pressure and yesterday we should have had a nice selloff instead of a flat day, more or less. However, the real story is gold and its ability to not get crushed under the weight of a strengthening dollar.

Those who read my articles regularly know I am bullish on gold, mostly as a hedge against a weak dollar, but also for long-term inflationary pressure. Regardless, a higher dollar usually spells disaster for the price of gold and while the price has reached, in my opinion, a nice entry point it has held up rather well in the face of the dollar. This is telling me that clearly demand for the yellow metal is in high demand and the fundamentals remain strong.

It is also telling me that the flight to quality has begun as the dollar increases, gold increases and equities decline. As stated several times, the market has priced in perfection for economic growth which should scare you to death because we will never get perfection. The fundamentals of the economy remain weak, regardless of what you are hearing or reading, and this weakness will become apparent moving forward into the fall.

I think it is evident that 3Q GDP will surprise most, but not at a 4.5% growth rate. I think a number of between 0-2% is about right, but hey let’s not let the facts get in the way of the new bull market. Unemployment, housing and commercial real estate are the major weakness in the economy and until we get actual stabilization in these areas, not just a one month reading, but a multi-month reading, then GDP will not grow at some of the ridiculous numbers of 4%+ that we hear being kicked around.

As the dollar weakens today we will see some strength return to equities, but we will also see gold move higher as well. I do not think this trend is long-term as I believe that firms are positioning themselves for the flight to quality that will happen in the next 30 to 60 days. The fall is usually weak for the markets and this is a cyclical move, in my opinion, however the coming market turmoil that is expected will exacerbate this move and we should see nice dollar gains followed by higher gold prices.

I believe that we will have several entry points for gold so I would recommend dollar cost averaging in over the next couple of weeks, buying on weakness. I really like the metal below $960 an ounce, but it could go lower, but I am a long-term bull. Volatility is going to be high in the near future so buy with your head, not your emotions. If you want to trade it then use charts and disregard my comments as I am a holder of the metal, not a trader. If gold is too rich for your blood then buy silver which I believe has plenty of upside potential, perhaps even more than gold especially longer term.

I own the GLD and SLV.

A Market Top Signal

Posted by Ray on August 7, 2009 under Main | Be the First to Comment

We have commented on the dollar’s weakness for a while now, but today we are seeing surprising strength in the dollar index. This is telling to the markets potential future behavior as investors tend to move into the dollar when the economy is questionable or they foresee potential problems.

For an example of this move just look to last fall when the dollar had huge gains against all major currencies. Why do people move to the dollar during economic turmoil is a very important question and the answer is fairly obvious, we have the most liquid market in the world, you can buy whatever term of government debt you want from 1 day to 30 years, and you will get your money back since we have never defaulted on our debt. However, while we guarantee your money back, we do not guarantee the buying power of that money.

The dollar’s strength today, in the face of a “better employment report” or the latest “green shoot” the dollar should be declining in value as the risk trade should be on. The problem is that it is up over 1% for the day and, in my opinion, is signaling that some major players think there could be some rough days ahead in the risk trade. I do not think you need to be a rocket scientist to figure out that it is nearly impossible for the markets to go straight up, but it has since July.

I do not have any data on who is buying, but my spidy senses are tingling and when you see a contrary indicator go off, equal to the markets move, you have to react. I am reacting by reducing my US equity exposure to 15% and I may take all US equities off the table by the end of the day. The other point of interest is that even with such a move in the dollar commodities are rather tame, gold is down slightly, silver is up and oil is down slightly. With such a move in the dollar these commodities should be crushed today.

As you know I am no bull in this market, a first time in years I might add, but this should make everyone pause and reflect on your current allocation. Corporate bonds are a good haven, in my opinion, as they are only pricing in flat GDP growth versus the S&P pricing in 4.5% GDP growth. I also like PCY which is an ETF sovereign government debt fund yielding over 6%, I do own this security, which could be a good place to go for 2 reasons:

1. It is out of the dollar, which I am a long-term bear on, and;
2. It has a nice yield and has performed fairly well during the last economic downturn, it recovered very quickly.

Here is the DXY Chart:

Disclaimer: I own PCY.

Unintended Consequences: The Dollar’s continued Decline

Posted by Ray on August 5, 2009 under Main | Be the First to Comment

Whether it is really an intended consequence or not is up for debate, however what is clear is the dollars rapid rate of decent to the basement. The index has been lower in the past, but the economic crisis last year boosted the dollar’s strength against every major index until the early part of summer when the risk and inflation trade kicked into high gear.

The consequence of a weak dollar is of great concern to me as it has consequences that most Americans either do not know about or do not fully understand. A weak dollar is good for our exports, but it also has an inflation factor for us that can sneak up on people. Commodities are priced in dollars so when the currency declines everything we use on a day-to-day basis increases such as gas and food. While the government thinks that gas and food have no or limited inflationary effect on people, I have to disagree since most people like to eat everyday and occasionally fill up their gas tank.

There is no question between the correlation of a weak dollar and the upward momentum of the equity markets. There are various reasons why the market has gone up over the past few months, it was massively oversold, but clearly the weakness in the US Dollar was perhaps the largest contributor to equities gains. As you can see below, the correlation is obvious between the dollar’s weakness and rising equity prices. Although there seems to be a decoupling between the two over the last few days, the longer term correlation is still very evident.

Every time the dollar declines 1% we see about a 1% increase in equities which means there is no real gain in stocks as Americans buying power was simply reduced. The reason for the dollars decent, which has been years in the making I might add, is because of our loose monetary policy. That policy has become increasingly looser since the beginning of the financial crisis and the saving grace of the US dollar was its liquidity as investors bought up dollars at a record rate last fall.

There seems no sign from the Fed as to when interest rate tightening might happen although many think interest rate hikes are closer than we think. Tightening our interest rates is the best way to support the dollar along with fiscal responsible spending which would mean no more spending by our government at this point. However, personally, I do not think the Fed has the stomach to tighten rates anytime in the near future, perhaps in 2010, but the Fed has been influenced way too much by the markets. In my opinion the Fed has abandoned its original role

On top of a poor monetary policy we also have massive amounts of debt being issued by the Treasury which is diluting our dollar even more. At this stage, we are heavily dependent on foreign governments to buy our debt. We saw what could happen if foreign governments slow or stop their purchases during last week’s 2 year auction where the bid-to-cover was 1.92 and rates shot up. If foreign governments stop buying our debt we are in huge trouble and will have to do more “quantitative easing” than we currently do now.

If the dollar index continues to slip then we could be facing huge problems such as losing our status as the world’s reserve currency. The only thing preventing that now is the fact that there is no other market that can handle being the reserve currency. The Euro and Yen are contenders, but those markets still are not as deep and liquid as the treasury market.

However, if we do loose our reserve currency status or the dollar index slips into the 60 area it is possible that foreign bank’s start dumping the dollar which could start the beginning of a crisis in the US dollar. As of right now I see an orderly exit out of the dollar, but if the orderly exit turns into a run for the exit because someone smells a fire then that is when we will have a big problem. It could very easily turn into a dollar collapse and no one is really sure what would happen because it has been unfathomable at any other time in our history.

Not only have we never seen anything like that in our lifetime in America, but most people think it could never happen, presumably because we are America. Not only could it happen, but eventually it is more than likely a probability that it will happen. Clearly no one knows exactly when or how it will happen, if it happens at all,, but one thing is for sure it will be because of a lack of confidence in the US dollar.

I do not root for such a thing to happen and I hope it never does happen, but at the very least it looks as though that the greenback will have some tough times ahead. This is one of the reasons why I am bullish on international investments, gold, silver and other hard assets as they are a hedge against a weak dollar. Buying commodities is one of the best ways to protect your and preserve your buying power.

Inflation, gold, silver and you

Posted by Ray on July 24, 2009 under Main, Markets | 2 Comments to Read

Contrary to popular belief there is a very high probability of inflation in the near future or, at the very least, a dollar worth less. I know the current debate is that we have deflation right now and inflation just doesn’t exist. Deflation is only in certain areas like TV’s, cars, real estate, and other consumer goods, however when it comes to food and energy prices are up. While prices are not as high as they were last year they are high enough to spark concern that we will have higher prices during an economic downturn. Evidence of inflation is at the grocery store, the gas pump, I know $2.60/gallon is supposed to be cheap for gas, but I guess I am old school on that issue, and the precious metals markets which are all higher than a year ago.

The shear fact that the dollar is worth less is a sign of inflation and will cause prices to rise in the US. The inflationary pressure is from the Federal Reserve’s drastic increase in the money supply which has not even fully made it into the market yet. Regardless, inflation is coming so what can you do to hedge against it. You can buy TIPS, but I feel that the CPI under estimates actual inflation therefore I like precious metals, the historical way to hedge against inflationary pressure.

What are precious metals – There are several kinds, but the more popular are gold, silver, platinum and palladium. There are different ways to play each of these metals and no they are not just for nut jobs either, they have actual value. All precious metals have a role to play in industry, even gold, and offer investors a way to profit from an economic recovery or inflation. Silver, palladium and platinum have a large industrial roll and are used in many of the products you have in your home and car. Gold is primarily used in jewelry, but has some industrial use.

Each of these metals are decent plays for inflation, because they are priced in US dollars, or if the dollar continues its decline. The problem is that if the dollar is in decline or inflation takes hold you really do not make money with metals, you simply preserve your buying power. That is a difficult concept to wrap your mind around, but true nonetheless.

Out of all the metals I have to say that I like silver and palladium more than the other metals, for various reasons. Palladium, and platinum for that matter, is a great “green” play as they are used to remove CO2 from cars and other industrial filtration systems. Palladium shows real promise in the use of hydrogen cars because palladium can hold up to 900 times its weight in hydrogen and has a very high melting point. Palladium is part of the platinum family, but is much cheaper than platinum and rarer.

Silver is used in everything and is not recycled so demand will always be there and the metal has a finite supply on Earth. Some say we will use all of our above ground supply within a decade or so, but I do not have proof of that. It is a cheaper metal and a highly liquid market which makes it attractive to many investors. In fact silver has outperformed gold over the past 6 or 7 years now going from about $5 an ounce to as high as $21 an ounce last year.

Gold is a good investment and has some industrial use, but 70% of gold is used for jewelry and investment purposes than anything else. It is the traditional hedge against inflation or major declines in the dollar and the market is very liquid. However, all precious metal markets are volatile, but the same can be said about stocks.

Ownership of these metals can be accomplished through investing in stocks that mine the product or ETF’s that mimic its price, GLD or the SLV. Platinum and palladium can be owned through mining companies or you can physically hold the metal, supposedly there will be ETF’s for both metals in the near future.
Depending on who you listen to either metals are going through the roof or they are going to tank. I believe that if you use them properly, as a hedging tool, then you will do OK over the long-term. It is recommended that you hold between 10 and 20% in metals, but I consider the allocation a personal matter left up to the investor.

Why own these at all – The mere fact that the dollar has decreased in value so drastically is reason enough. I am not one to say that the world is going to hell in a hand basket, although who really knows, but I am one to say you need to be prepared for anything. That means if the dollar declines suddenly your precious metals will have persevered their buying power while your paper assets, i.e. dollars, will be worth much less. Eventually you would exchange your metals for dollars, but they would buy the same amount of goods.
Year-to-date gold and silver are up in value which is why you should own them in your portfolio. I personally would like to see gold lower in price before entering a position, but that is a decision you would need to make. Diversification is key to investing and that is what you are doing if you decide to enter this market, but you are not alone as metals have gained tremendous popularity over the last few years.

The downside to owning metals – Taxes on the earnings are much higher than capital gains tax. Instead of the 15% you will be taxed at 28% regardless if you own the metal physically or through an ETF like the GLD or SLV. However, physical sales under a few ounces is private, but you still need to report the gain, if any, but if it is over 10 ounces then you will be receiving a 1099.

In short, metals are a great play especially long-term. Considering platinum group metals are rare, very rare, and Russia is the primary supplier of this metal it can’t hurt to own some, especially if you want that green play. Silver is projected to run low in the near future and is trading well above its historical 15-1 gold-to-silver ration(GSR) (this means it would take 15 ounces of silver to buy 1 ounce of gold) and is currently trading at 69-1 GSR which, in my opinion, makes it a screaming buy.

China is also a huge buyer of all of these metals and as the country gets richer demand will increase for everything from jewelry to cars, all of which use platinum, palladium, silver and some gold. The country also increased its gold holdings dramatically over the past few years which shows gold always has value. Even insurance companies, Northwestern Mutual, bought gold recently, these are not dumb people and I believe when central banks and other successful people start buying it might be wise to follow suit.

Here are charts n SLV, GLD versus the S&P 500:

Disclaimer – I do not own the GLD or SLV, I own DBP which tracks the precious metals index. I only buy currencies, ETF’s and mutual funds

And for 5 years SLV and GLD look much better:

The China effect on the dollar

Posted by Ray on July 6, 2009 under Main | Be the First to Comment

Every other day, literally, the Chinese say something negative about the dollar and then support it the next. This is a cause for concern and should make people second guess whatever public action they think the Chinese are doing.

The other more recent concern is the fact that the Chinese have started to move towards making the Yuan the reserve currency of the world. At least that seems to be their intent based on recent news that “Six Shanghai companies signed contracts with counterparts in Hong Kong and Indonesia on Monday to be the first to settle business deals in the Chinese currency, also known as the renminbi.”

This is on top of India’s comments, Russia’s comments and even Brazil had discussed settlement of trade between them and China to be outside of the dollar. The move will not happen overnight, but the Chinese actions speak louder than words when it comes to what their intent is. They are moving towards shorter term treasuries from the longer end which shows a willingness to just let their holdings mature and not roll them.

This is just not good news for the dollar, but it will take years to move away from the USD as the reserve currency. It will happen, but no one knows when.