Midweek Briefing -- The
U.S. Dollar: A Safe Heaven in Perception Only
Dear OI Reader,
Jim Rogers just made a few heads spin.
In a recent interview, he said in no uncertain terms that the
U.S. dollar is no safe heaven.
Then, in the same interview, he also made very clear that his
LARGEST investment position is being long the U.S. dollar.
However, while Rogers seems to be contradicting himself, there
is a method to his madness. Today we’ll take a look at Rogers’ latest move, and
a look at the bigger picture shaping up in the U.S. dollar.
Here’s the story…
Fools Float the Dollar
Jim believes that there is more turmoil coming for global
financial markets. As that happens, Rogers expects investors to continue to
flee to what they think is a safe haven… that being the U.S. dollar.
What Rogers is doing can only be classified as a trade, not an
investment.
An investment is based on sound underlying fundamentals. You
make an investment because you believe the market has mispriced the value of a
particular asset and believe that eventually price and value will coincide.
A trade is based on playing the greater fool theory. Rogers owns
the U.S. dollar because he believe its future price is not going to be
determined by its true intrinsic value, but rather by the misplaced belief of
market participants (great fools) who think it is a safe haven.
I expect that he is probably right and the U.S. dollar will at
some point in the near future be stronger than it is today. I also believe that
at some point this party is going to end.
The Reaction to a Yuan
Devaluation -- Much Ado About Very Little
The Chinese “devaluation” rattled global markets in August. I’m
afraid I don’t see this move as being nearly as dramatic as the market has
taken it to be or the media made it out to be.
For some context on the size of this Chinese “devaluation,” have
a look at the graph below. Next to the movements of virtually every other
currency in the world, the weakening of the yuan looks pretty minor.
Global
Currencies vs. the U.S. Dollar
Source
of image: Oanda
Over the past two years, the yuan has weakened against the
dollar by 3.28%.
The Japanese yen has dropped 20.73%.
The euro is down 18.36%.
My Canadian loonie has slid 27.73%.
The Australian buck has declined 31.32%.
Those moves are in the currencies of the most stable countries.
Within the BRIC, nations, the Brazilian real is down 62.1% against the dollar
and the ruble is down 102.53%.
Given how virtually every other nation has had its goods and
services go dramatically on sale over the past year and a half, is it any
wonder that China got tired of being at a competitive disadvantage?
Therefore, I don’t view China allowing the yuan to weaken
modestly as a reason to start running around with my head cut off. Is China’s
economic growth slowing? I think most definitely, and that is why China is
trying to reduce the competitive disadvantage that was created by its currency
not devaluing at all while most others did in a major way.
China’s currency move wasn’t motivated by the yuan’s
relationship with the dollar. It was motivated by the yuan’s relationship with
all of the other currencies.
What Could Ultimately Be
the Undoing of the Mighty Dollar?
The relationship between the strength of the dollar and the
prices of commodities could not be clearer.
U.S.
Dollar vs. Commodities
Source:
StockCharts
The chart above shows how from September 2012-June 2014, the
U.S. dollar index (black) didn’t move around much, and neither did the S&P
total commodity index (blue). Then when the dollar went on its tear starting
midsummer last year, the bottom fell out of commodities.
For every 1% the dollar strengthens, the prices of commodities
seem to drop two-three times as much.
I don’t pretend to fully understand this relationship. Do
commodities react to the dollar directly? Or does the dollar react to the
fundamental supply and demand factors that influence commodity prices?
Perhaps it is a bit of both.
I suspect that when the incredible strength of the dollar
reverses, it is going to do good things for the price of “stuff.” And like Jim
Rogers, I do believe that the dollar will reverse course… I just don’t know
when.
As Rogers observes, the U.S. dollar is no safe haven. The United
States is the largest debtor nation in the world. In fact, despite having
significant exposure to it, Rogers describes the dollar as a “flawed” currency.
The only thing that is supporting it is that current perception that the dollar
is a safe haven.
That sounds like the definition of a bubble.
In 1999, most everyone with any stock market experience knew
that technology stocks were incredibly expensive relative to the actual
earnings (assuming they had earnings) that these companies could generate. Yet
people kept buying them simply because of the perception that they would
continue going up.
Just like the U.S. dollar today.
Those technology stocks kept going up until they didn’t. And
then they crashed because there were no underlying fundamentals to support
anything close to their stock prices.
In 2007, it was not hard to be aware of the fact that U.S. house
prices had become completely unhinged from historical norms in relation to
average family incomes. Yet people kept buying them, because it was assumed
that housing prices would never crash.
That party ended too. Badly.
The ultimate cause of the undoing of the dollar may ultimately
come from the rapidly transforming oil market.
For decades, the U.S. has been the most important customer for
the world’s major oil-exporting nations. Truly, this is the basis of today’s
“petrodollar” -- a multi decade dollars-for-oil relationship between the U.S.
and the Middle East.
Now with U.S. oil production having soared and long-term demand
growth likely to be nonexistent, America’s importance to those major oil
producers has diminished.
The important future customers for oil exporters are found in
the fast-growing and highly populated Asian nations. These are the countries
that are going to be thirsty for oil in the coming decades and provide the
market for exporting nations.
Since that is the case, the need for the Saudis and other
exporters to have their oil priced in U.S. dollars has diminished greatly.
It doesn’t take a rocket scientist to figure out what happens to
demand for U.S. dollars if the Saudis start accepting Chinese yuan in exchange
for their exports. And you can bet that Russia (the other major exporter) would
enjoy nothing more than reducing the U.S. importance in the oil and financial
markets.
Next month, China is expected to launch its own global crude oil
contract that will NOT be priced in U.S. dollars… it will be priced in yuan.
All of a sudden, the idea that the U.S. dollar could be bypassed in oil market
transactions seems very real. Indeed, this could be the end of the petrodollar
as we know it.
The U.S. dollar will remain strong until it isn’t. The timing on
that is unknown, but markets can change much faster than expected.
Keep looking through the windshield,
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