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King
Dollar is coming back with a vengeance, threatening to thump commodities,
offering to lift the U.S.
out of recession, and promising to restore the investment primacy of U.S.
equities. On this rallying cry of the desperate blind-eyed optimist crowd
(who have been wrong for the last seven years), I wish to make two points:
First, the U.S. dollar's rally will be short-lived and capped at a resistance
level which once served as support for 36 years!
Second, the first point is becoming
increasingly irrelevant because
the rally in commodities is evolving more into a supply/demand and world fiat
currency story than a USD story. This is especially true since the rest of
the world is beginning to eschew the USD as the world's reserve currency and
adopt their own inflationary, currency-debasing
policies. Analysts have shown that, thus far in the commodity rally, between
25 and 50% is attributable to a decline in the U.S. dollar, depending on the
commodity. I have read that the number is closer to 50% for oil and 25% for
grains. I expect the importance of the dollar's relative strength to decline
as the commodity rally resumes.
For now, an opportunity exists for
those who are able to exploit the vast majority of investors who remain
trapped in old paradigms and a U.S.-centric view of the world.
King Dollar
King Dollar is rapidly evolving into
the oxymoron of the century. The recent rally in the U.S. Dollar kind of
reminds me of the best team in a weak league. Take college hoops, for
example. American
University came out of
nowhere to win the Patriot League this year and was the conference
representative in the NCAA tournament of 64 teams. The Patriot League is the
conference John Feinstein chronicles in his book "The Last Amateur."
The title tells the story. Now compared to the other teams in the league
(Army, Navy, Colgate, Bucknell, and others) American U. was spectacular this year. But
compared to other teams in other leagues they couldn't compete (as evident by
their sudden exit in the NCAA tourney).
Think of American U.
as the U.S. Dollar and the Patriot League as the world of fiat currencies. Think
of the Athletic Coast Conference (ACC), generally believed to be the
strongest conference, as precious metals with Duke and North Carolina representing gold and
silver. Occasionally there is an upset, but over the long run, the ACC
dominates. To extend the analogy a little further you could add other
conferences representing other commodity groups-the Big East (energy), The
PAC 10 (grains), and The Big 10 (metals). The ACC (precious metals) was not
quite as strong this year compared to their usual dominance over
the other conferences (other commodities). But all of these
conferences (commodities) will continue to thump every team (fiat currency)
in the Patriot League. Eventually the ACC (precious metals) will regroup and
reign supreme again.
Here the old paradigm is on display as
we witness the price of gold and silver drop because
Pavlovian traders are selling the metals in response
to the USD is rising against a basket of weighted currencies. These traders
should ask: Rising against what...its weaker sister currencies? Rallying
against the Euro and the Japanese Yen is much more of a reflection of Euro
and Yen weakness than any measure of USD strength. There is no other way to
describe this race to the bottom for the world's leading currencies other
than pathetic. And how high could the USD rise. To the extent that this
question still matters, the answer is visible in the chart below:
(Chart
courtesy of www.thechartstore.com)
Over the course of the last 36
years, the dollar tested the 80-level on several occasions, but each time it
held. In 2007, the U.S. Dollar's plunge below this multi-decade support level
marked the death of its supremacy as a currency. A rally back to the old
support level would not be out of the question, but an effort to move through
80 most likely would. At this level, the old support level now
becomes resistance.
There are a plethora of fundamental
reasons that will likely cap any rally the dollar might muster. We currently
have the lowest real interest rates since the early 1980s. As the Fed turns
its attention from the credit crunch to the real economy it is going to see
the malaise of the American housing market and declining wealth and income
growth. The Fed may be forced to lower rates again after a brief pause. This will not support the dollar.
And who are they trying to kid about a
strong dollar stopping the commodity rally in its tracks? You almost have to
be a masochist to listen to the Dollar-bull/pro-U.S. equity crowd after they
have missed the commodity rally for the last seven years. My message to them
is come on over and join the winning team. It seems like every time I tune
into a financial channel I hear someone saying, "Boy this oil and commodity
rally feels a lot like Nasdaq 1999." Let's
see...Yahoo (YHOO)
had a PE multiple approaching infinity and Conoco Philips (COP) has a PE moving toward 9. Tech
stocks still have multiples higher than many commodity companies whose growth
rates are much higher.
Looking at the Barrons
Spring 2008 Big Money Poll Results, we see that financial and tech stocks are
still the two most highly-recommended groups:
(Poll
courtesy of Barrons)
As a contrarian indicator this is
wonderful news for commodity bulls. The mainstream has still not been
converted. Speaking of contrarian indicators, the other thing I see on
financial TV is this seemingly never ending barrage of
"professionals" sharing anecdotal stories of waiters, dry cleaners,
shoe shiners and the like asking them about commodity investments. Surely,
they say, this marks the top. Maybe some of these investment
"professionals" should step down from their haughty
high-horses and consider using themselves as the contrarian indicator. And I
keep hearing about the magazine cover contrarian indicator-like when Business
Week declared the death of equities on its cover in the early 1980s
before the 20-year bull run and when The Economist said oil would forever be
stuck at $10/Barrel on its cover in the late 1990s. My take is that is
that you might see playmates operating longwall
shearers and walking draglines that mining coal on the covers of Playboy and
Penthouse before this boom is over.
And the King Dollar pack really hates
it when you tell them the U.S.
doesn't control commodity prices anymore. These guys are trapped in U.S.
Centricity. The CEO of Rio Tinto (RIO)
just said that "Markets remain strong and the prices of many of our
products are at record highs, bearing out our view that the U.S. slowdown
will have little effect on global metal and mineral supply and demand
imbalances. " Commenting on the China
Purchasing Manager's Index rise to another record, the head of economic
research for CLSA (a highly-reputable and relied upon firm for gauging the economies of Asia)
just last week said, "Strength was evident across the board. While there
is understandable concern that weakness in the U.S.
will negatively impact China,
there is no evidence of that yet."
A momentary uptick
in the dollar is not going to get in the way of this commodity freight train.
Addressing the deficiency of having a U.S.-centric investment view of the
world, Frank Holmes of U.S. Global Investors writes:
"As Americans, we must be aware
that 95 percent of the world's population lives outside of North
America and is striving for the same modern luxuries that we
often take for granted - amenities such as heating and air conditioning,
reliable electricity and efficient transportation. A global land grab is
under way as countries like China
and India shore up their
commodity supplies, often in countries the United States has shunned. As
resource prices rise, so has countries' desire to take a bigger share of
resource production, either through re-negotiation or outright
nationalism."
The Dry bulk shipping rates are
climbing back to record highs in spite of the U.S. economy not because of it. Ships are being diverted from the U.S. They are
needed to make up for the excess demand that exists for vessels carrying dry
bulk to China.
The U.S.
is quickly becoming yesterday's news. King Dollar ideologues hate to hear
that and their subjective bias prevents them from making optimal investment
decisions. And therein lays the opportunity for the rest of us. Eventually
they will be forced to capitulate. That will likely mark the end of the rally
for commodities.
Regarding timing the end of the rally,
most commodity bulls are holding to the 15-20-year rotation pattern that was
held for 150 years. If you mark the year which the rotation out of stocks and
into commodities occurred at 2001, then you would have the rally ending no
earlier than 2016. It is inexplicable to me how the parade of investment
advisors who appear on financial TV either are ignorant or choose to ignore
this faithful pattern which has existed since 1860! My view slightly differs
from the majority of commodity bulls.
As I have written in past
commentaries, I believe that we are likely to see a final
"super-spike" phase with the CRB rising 20-fold from its year
2000-2001 low that ends in a couple of years. My case may have
been strengthened a little last week when the Goldman Sachs energy
analyst, who correctly predicted triple-digit oil back in 2005, called for
the "possibility of $150-$200 per barrel oil price" over the next
six-24 months. This would mark a 20-fold rise for the price of oil, slightly
less than a double from current levels. A spectacular super-spike in early
2010 that crushes the U.S. Dollar and U.S. stock market bulls into
capitulation awaits. You should be buying now and
selling to them then.
Kurt Kasun
www.greenfaucet.com
A
contributing writer to GreenFaucet.com, Kurt Kasun writes a high-end investment timing service, GlobalMacro, which is focused on identifying
opportunities that produce returns in excess of market with reasonable risk.
He is strategically located in Washington,
D.C., a key to maintaining
contacts and relationships which help Kurt understand global policy and economic
factors as they emerge. His investment approach has always been macro in
nature largely due to his undergraduate studies at the U.S. Military
Academy at West Point (B. S.
National Security, Public Affairs, 1989) and his graduate studies at George Mason University
(M.A. International Commerce and Policy, 2006).
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