Friday, May 29, 2009

The Vicious Cycle of a Falling Dollar.

When it comes to the direction of the US dollar over the long run, all I can shout is "Watch out below!"

There's no doubt of the general direction and the powerful trend of the US dollar. It begs a very important, very relevant question:

So what's up with the strength in bond yields, oil, and other commodities? Two factors seem to be at work. First, China has begun a legitimate turnaround. In fact, some analysts see a “V”-shaped bottom forming.
However, while that's great for the Chinese, it doesn't do us much good. If rising demand from China drives oil prices higher, the effect resembles a tax hike for the American consumer. True, we might get some ancillary benefit from Chinese growth, but it will be minimal compared to the cost of higher interest rates and energy prices.
The second factor that could be pushing bond yields and energy higher is the unprecedented increase in the U.S. monetary base – the sheer ocean of liquidity being poured into the financial system. Investors, who realize that the value of an asset often comes from its limited supply, are growing nervous about currencies in general. As the world's reserve currency, the U.S. dollar will bear some of the brunt of that nervousness.
Put yourself in the shoes of a foreign investor. Which would you choose to own – a currency that is being printed faster than any other in history, or an asset that is rare and difficult to produce? No wonder investors are demanding bigger yields from T-bills and turning to commodities as stores of value. Certainly China has been investing in stockpiles of commodities, far above what they need.
Recently I received another very thoughtful missive by the editor of The Complete Investor Dr. Stephen Leeb. He's not always correct but he always makes me think. Here is what I thought was the best part of his letter:

"If foreign investors are moving away from the dollar and into commodities, they will give the U.S. economy one additional obstacle in its struggle towards recovery. Not only must we contend with deleveraging from the consumer side, in the form of banks still refusing to lend, but now we face higher interest rates, which will affect mortgages, and higher energy prices, which restrain economic activity.

"Speaking of interest rates and mortgages, the Fed has one more tool it can use to encourage home buying. It can directly buy up long-term bonds. This would push bond prices higher, and restrain yields and interest rates, making it easier for people to service a mortgage. In fact, the Fed has been doing just that.

"However, there is a risk. If the Fed finds it must ramp up its bond purchases, it will lead to more dollars being pumped into the financial system. That, in turn, will give investors even more reason to sell them. The result would be a vicious circle [cycle].

"We hope we are wrong about this, and that the markets are actually discounting a surge in consumer demand. If so, we will be pleasantly surprised. But that's not how it looks.

"Turning to energy, we feel obliged to make some comment on the current administration's policies. So far, the government has directed a piddling amount of money towards alternative energy development, with the bulk of funding going to energy conservation.

"Now, in one sense, there's nothing wrong with saving energy. However, in the context of a worldwide economy, it carries a few problems.

"America today still considers itself to be the world, which is a fatal error. Instead, one must recognize that the U.S. is part of an integrated worldwide economy.

"If Americans buy fewer gas guzzlers, that may make U.S. cities healthier. However, conserving resources which we will need to build an alternative energy system – one that is absolutely vital for the future – is a mistake. Here's why...

"If Americans conserve oil, that will keep worldwide oil prices low. Low oil prices make it easier for developing nations like China and India to grow their economies – and raise their oil consumption. That will drive prices higher in the long run anyway, but in the short run it is a zero-sum game in which we lose and they win.

"Instead, what we need is a positive game in which everyone wins. Our nation needs to get on its horse and begin building alternative energy. Otherwise, we will soon be faced with higher taxes, in the form of higher energy and commodity prices that will make it more difficult to build the alternative energy infrastructure that we will need down the road. The development of alternative energy infrastructure and technology now (which can also be exported) will deliver far greater benefit to the entire world."

Great points, Dr. Leeb. No wonder I subscribe to The Complete Investor .Oil prices will most likely rise in the long-term, no matter what happen with the Green Revolution, as demand exceeds supply.
Right now, as Dr. Leeb and many other conscientious economist and scientist agree, we must discourage the growth of total worldwide demand (not just American demand) and develop alternative energy sources while we can still afford to. That is the key, get sustainable energy sources going while there is still interest and the resources to do so.
Now a comment about the US stock market. In the short-term we are not particularly bullish on the stock market. We see the market caught in a trading range. Within the next month or so, we expect a top will form. After that, prices will fall and possibly retest their lows.
As for gold and silver, Thursday's movement showed silver closing above $15 and gold right around $960. This doesn't speak well when it comes to investor confidence in the value of the dollar. Some analysts speak of some impending profit taking just around the corner for the precious metals.
But in an interview from Hong Kong, noted market analyst Marc Faber went way out on a limb and said he sees the U.S. entering a “hyperinflation&... that will be “close to” Zimbabwe.

“I am 100 percent sure that the U.S. will go into hyperinflation,” Faber said. “The problem with government debt growing so much is that when the time will come and the Fed should increase interest rates, they will be very reluctant to do so and so inflation will start to accelerate.”

Faber added that, “I don’t think that gold will run up right away. I never sold gold and I’m still buying gold … [because it] has been an adequate hedge against inflation … If you bought it in 1980 at the price of $850, then it hasn’t been a good hedge against inflation, but if you bought it in 1999 at $251, then it has done very well.”

Inflation? No way, Nadler says. He might as well have been responding to Faber when he said: “Where is inflation? A speck on the horizon.”

Nevertheless, the funds continue to pile into metal. Hedge funds and other large speculators increased their net-long position in New York gold futures last week, by 7.7% over the previous week, according to CFTC data.
Candidly speaking, with massive layoffs coming in autos, auto-parts and the accelerating demise of hundreds of banks, unemployment data will keep rising, and within a brief time, credit card and other consumer debt defaults will start escalating.
There's a truck load of really bad, toxic-smelling "delayed news" that's about to hit the fan. My most reliable sources tell me that there is more downside coming for the S&P in the coming weeks and months, and the "vicious cycle" of the break-down of the dollar is far from over.
The US Treasury faces a rapidly rising risk of a really embarrassing auction of new debt that may shock Wall Street. And gold stocks as measured by the Market Vector Gold Miners ETF (NYSE:GDX) indicates gold isn't done rising. The following chart doesn't even show the addition 4% jump the GDX made on May 28th.
You can see more of these kind of charts by looking at a great closed-end fund like ASA Ltd (NYSE:ASA) or by seeing a chart of a medium-size gold producer like IAM Gold (NYSE:IAG).
This is a time to be a stock picker, a very patient stock picker. Stick with quality and stick with what you know and believe in. Own enough shares of commodities and commodity producing companies.
And make sure you use any pullback in gold and silver to add to your position. Gold remains our number one inflation hedge, and silver, which may in the long-run outperform gold, is every bit as important.


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