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Today's WrapUp by Mike Hartman 05.23.2003 Mon Tue Wed Thu Fri Archive |
It’s as Good as Gold (Dollar or Euro?)
I have written before that we are truly living in historic times. Clearly as each day passes history is made, but it is more pronounced in the context of today’s global economy coupled with extraordinary geopolitical tensions. History was made today in the financial markets with the Euro trading above $1.18 for the first time since its inception. The Euro was introduced to the financial markets in January 1999 at US$1.17, fell to a low of $0.82 in October 2000, and has risen 44% from the bottom to close at 1.1793 today. Most everyone is familiar with the cliché, “Good as Gold.” That was the marketing campaign that was used by our government and the Federal Reserve to launch the Federal Reserve Note, or what is commonly referred to as the dollar. They needed to market the idea that paper representing gold was as good as gold. Let’s take a closer look at the numbers for the last few years to see if the cliché still holds true today.
Before we get to the numbers I would like to encourage all investors to take the time to study the history of money throughout the ages, and especially the monetary history of the USA for the last 200. It is very important to look at the U.S. Dollar since the beginning of the Federal Reserve in 1913, government confiscation of citizen’s gold in 1933, the Brettonwoods Agreement that followed World War II, the London Gold Pool of the 1960’s, the fixed exchange rate system that transitioned to today’s floating exchange rate system, Nixon’s closing of the gold window in 1971, and where all of that has led us to today.
When I reflect back on the studies that I have done on the history of money, it is easy to get philosophical. It reminds me of a favorite line in one of Edgar Guest’s poems that says, “Time present and time past are all contained in future time.” I also like to be reminded that history doesn’t always repeat, but it sure does rhyme! History is packed full of examples detailing various money systems and the rise and fall of countless currencies. The fact of the matter is that ALL fiat currencies since the beginning of mankind have failed, without exception. Fiat simply means that the paper money we use today is considered money because the government has “declared by decree” that it is money. In your studies of money, you will quickly learn that money must have specific characteristics. The two most important criteria for money is that it can be used to facilitate exchange and should maintain its worth as a store of value. Our dollar has worked well to facilitate exchange, but it has done a poor job as a store of value. Since its inception, the dollar has lost 95% of its purchasing power.
Please understand that I am not here to bash our policymakers, but we must look at the situation objectively in order to make good financial decisions. Most investors seem to be confused as to what is going on in the markets and what to do next. How many of you out there in Investmentland have actually diversified part of your wealth outside the U.S. dollar? Most investors don’t know how to buy Euro, Swiss or Canadian Bonds, most investors don’t know how to buy commodities on the futures exchanges, and most investors wouldn’t be caught dead selling their tech stocks and taking the proceeds to a coin shop. I think most investors are burying their heads in the sand, choosing to stay in denial, and looking the other way when it comes to considering what actions to take when it comes to a rapidly falling dollar. Please do not delay in educating yourself on the currency market, since that is the key to the stock and bond markets. The stakes are extremely high for the dollar to remain as the single reserve currency of the world. When we look at the reasons for going to war in Iraq, the overt reason was to go after the terrorists and get rid of the weapons of mass destruction. Some were speculating that the reason was to secure the oil reserves, but I would also ask you to consider if part of the reason was the dollar. In November of 2002 Sadaam Hussein refused to accept dollars for oil and would only accept euros. If the rest of the oil producing countries accepted the same policy, it would have accelerated the euro to reserve status side by side with the dollar. Just consider for yourself if Iraq’s “dollar policy” had anything to do with the war. Now let’s finally look at some numbers to see if the dollar stands up to its cliché, “Good as gold.”
Dollar, Euro and Gold
On January 28, 2002 the U.S. Dollar Index closed at 119.88 and today it closed at 93.13, for a loss of 22% over the last 16 months. The Euro bottomed in October of 2002 at $0.82 and today closed at 1.1793 for a gain of 44% in eight months. Gold bottomed in April of 2002 at $255 per ounce and today it closed at $368.30 for a gain of 44%. In just over a year the dollar has lost 22% in value while the Euro and gold have both gained 44%. If you take a look at the table, I have broken down the dollar bear market to look at the depth and duration of each dollar plunge and counter-trend rally. The prior declines averaged 173 days with an average drop of 11.5%. If we assume a similar fall on the current leg down, the index should get some temporary support at 90. I suspect the duration won’t be quite as long since the decline has been sharper this time. Right now I’m expecting a spike down to 88, then a rebound to move sideways.
| Point Gain/Loss | % Change | Duration in Days | ||
| 01/28/02 | 119.88 | |||
| 07/19/02 | 104.06 | -15.82 | -13.2% | 172 |
| 09/17/02 | 108.33 | 4.27 | 4.1% | 60 |
| 03/10/03 | 97.85 | -10.48 | -9.7% | 174 |
| 03/19/03 | 101.58 | 3.73 | 3.8% | 9 |
| Today | 93.25 | -8.33 | -8.2% | 65 |
Now let’s look at it from a different angle. On the graph you can see how the extensions of support and resistance from the prior bull market have provided temporary support along the way in the dollar decline. We will just have to watch and see where support kicks-in. The chart is in oversold territory with the Relative Strength Index below 30, but it can stay down for a sustained period of time. The RSI remained in the high end of the range for most of the period from 1995 through 2001, and similarly should remain in the lower half of the range for another three or four years. Currency trends tend to last five to seven years, and it will require a sustained period of declining dollar strength to correct our current account deficit, which is running at 5.3% of GDP. In the short term, Michael Woolfolk, senior currency strategist at the Bank of New York, sees this move taking the Euro to 120, while the analysts at Merrill Lynch are projecting the near-term top at 125.
Massive Stimulus
The dollar is falling because of the massive injections of liquidity that the Federal Reserve is throwing at the party. Nobody is going to take this punch bowl away. President Bush got his tax cuts this week, though it was half of what he was asking for. There is some heated debate if tax cuts are the right way to stimulate the economy. As I see it, they are pumping liquidity in all ways possible. After the tax cuts, we are looking at 50-year lows on interest rates and the Federal Reserve forcing huge blocks of cash into the markets via their open market operations. The stimulus provided by the Feds is already starting another round of mortgage refinancing with rates dropping again to historical lows. According to Freddie Mac, the 30-year fixed rate dropped to a record 5.34% this week.
According to BCA Research in their Global Investment Strategy Weekly Bulletin, “The world is awash with liquidity at a time of low yields and many risks. Once investors catch on to a promising theme, capital floods the asset class and produces rapid price extremes. The plunge in the dollar is the latest example of this phenomenon. This year’s collapse in corporate bond yields is another. The next will be a surge in stocks which goes further and longer than most expect.” One of the developments that fascinates me is to watch asset prices continue to climb in the face of a rapidly falling dollar. Massive liquidity is an understatement. Real estate prices are still rising, stocks have been rising and bonds have been going up, all at the same time. The Federal Reserve has been broadcasting lower interest rates, which continues to push money into bonds. Some analysts are projecting the bottom for interest rates at 3.0% for the ten-year Treasury Note. Anyway you look at it, the Fed says it’s safe in bonds, so investors are falling in line. The problem comes with incredibly low yields. Why would you go aggressively after 3% returns, and how much more appreciation can be left in bond prices? Not much, and that’s why some of the money is chasing the stock market.
Normally, when I see stock valuations at these levels, I say they must come down. From a technical standpoint the stock market is overbought and needs to take a rest, but the Feds are pumping it hard to stay up high. This is where we have to step back and consider another cliché, “Don’t fight the Fed.” In the past two years I have done well to fight the Fed by shorting the market, and going long precious metals as a hedge for the dollar decline. I’m not so sure I will fight them as aggressively on the short side of the market. While we are anticipating a broad market decline for stocks, it probably won’t be as deep as many expect. We have aggressively analyzed the high dividend stocks, biotechs, energy (especially natural gas), precious metals, and consumer staples. We remain in precious metals and foreign currencies to profit from the dollar decline, and wait patiently for the right entry points to go long some of our favorite stocks.
Fed Repo Agreements
The stock market is technically overbought and is fundamentally overvalued, but that doesn’t necessarily mean that it will go down. We live in unprecedented times and our leaders are taking unprecedented measures to fix our economic woes. The Fed has overtly stated that they will support the bond market should it become necessary. The statement alone has provided the necessary supports. The Fed is also supporting the stock market via their open market operations, otherwise known as “repos” or Repurchase Agreements. When the Fed buys securities off the market, it replaces those securities with cash. The cash creates a pool of temporary investment funds that are lately in excess of $30 billion. As of yesterday the pool stood at approximately $40 billion, which provided enough liquidity to keep stocks up for the week after the big sell-off on Monday.
You have read many times of Jim Puplava’s “flagpole rallies” where he details the four-step process used to launch stock prices. Michael Bolser of gata.org has done a tremendous amount of research on the mechanism of Federal Reserve Repurchase Agreements and their effect on the Dow averages. In his article titled, “Repurchase Agreements and the Dow” he goes into great detail to explain the whole process. I strongly urge you to read his article to get the background information. Jim Puplava will have Michael Bolser on his radio show in two weeks to go through all of the processes and implications of the Fed Repos. To make the long story short, just be careful if you are shorting this market, ‘cause it’s impossible for the Fed to run out of money. The market can certainly go up, but if it does you can count on a lower dollar.
Spin of the Week
Finally for the spin of the week, I’m gonna’ keep it light. We have a three-day weekend to enjoy, so I’ll just provide some spin and confusion of my own.
Inflation, deflation, reflation
Devaluation, revaluation, flagellation
Declining inflation, stagflation, disinformation
Default, regulate, monetize, and re-inflate.
Confusion, delusion…What’s it all about?
Strong dollar, weak dollar
Should I invest, or just get out?
See ya’ next week!
I hope you have a great weekend and best of luck to you in all of your investment decisions.
Copyright © 2003 Mike Hartman
May 23, 2003
Chart courtesy of StockCharts.com
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