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Musings Report #6 2-6-15 The Lowest-Risk Investment of the Decade?
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Thank You, 2015 Contributors
Key supporters of Of Two Minds continue to make their annual outrageously generous contributions for 2015. I am in awe of their support and can only hope to repay their generosity with content worthy of their commitment: William C., Michael J.R., Millie N., Wiliam B., John K., Navneet N.S., Roger H., John V., Don W. and Mark D.
The Lowest-Risk Investment of the Decade?
I am always searching for ways to add value to subscriber/contributor's lives, and this prompts me to consistently address health (which is priceless) and investing in the decade ahead, which is fraught with risks that few appreciate.
Here's the core context: a crisis that will remake the nation (and the world beyond America) looms a mere six years ahead. The authors of the book
The Fourth Turning: An American Prophecy - What the Cycles of History Tell Us About America's Next Rendezvous with Destiny make a very compelling case that a crisis that forces systemic changes occurs every 80 years. While any projection based on the past deserves healthy skepticism, it is remarkable how accurate the 80-year cycle has been:
1781: Constitutional Convention
1861: start of the Civil War
1941: start of World War II, an existential challenge to America on two fronts
2021?: the demise of an unsustainable resource/financial/entitlement/state structure
I suspect we get a multi-stage crisis: the first stage is unfolding now and will stretch into 2016 and perhaps even 2017: a breakdown in the stock market, a head-fake in energy, and the general destabilization of the status quo. This will be followed by a "recovery" that many will assume is permanent. But the "fixes" will only hold for a few years before the final crisis unfolds in 2021-24.
So where can we safeguard the assets we've accumulated from years or decades of labor? It's an impossible question, of course, as no one knows the future, but I think a strong case can be made for 1) the U.S. dollar through 2017, 2) energy assets, and 3) income-producing real-world assets. (I will discuss the latter two in future Musings Reports.)
As a USD bull, it often seems as if the USD is a currency everyone loves to hate, often because they see it as a proxy for all the U.S. policies they dislike.
I am not a fan of most U.S. policies, either, but as an analyst I can't let ideology or opinions get in the way of an objective assessment--especially one that could help small investors like myself preserve capital in an era of instability and disruption.
For the reasons outlined below, I see the USD strengthening for years to come. If we had to simplify this analysis down to its essence, it would be:
1. Any currency reflects the financial strengths and weaknesses of the economy that issues the currency; in terms of systemic stability, autarky (self-reliance), food, energy, capital flows (demand for the currency in global markets) and economic vibrancy (i.e. willingess to accept risk and failure), I would argue the U.S. has no peer in nations/regions with populations exceeding 200 million.
(This excludes Canada, New Zealand and Australia, all of which have resources, stable states and relatively small populations. Each has its own complex relationship to the USD.)
2. History shows the USD strengthens in crisis, and if we're entering an era of global crisis, the USD will once again be valued as a safe haven in a rising sea of risk.
Here is a somewhat detailed explanation of some of the key dynamics driving the USD higher. If this is of little interest, scroll to the bottom of this section and consider the charts.
Triffin’s Dilemma/Paradox
This tension between domestic policies and their international consequences is the heart of Triffin’s Dilemma. Triffin’s Dilemma becomes especially acute for the issuer of the global reserve currency, the currency that dominates global trade and currency reserves.
The U.S. dollar remains the undisputed reserve currency, and despite many proposals offered for alternatives, no such alternative yet exists.
Triffin’s Dilemma is also called Triffin’s Paradox, as you can’t have it both ways, i.e. have fiscal and monetary policies that satisfy both the domestic economy and the global economy.
Triffin’s Paradox helps us understand why the dollar’s rise is so destabilizing and difficult to reverse.
I have long held that that Federal Reserve faces stiffening domestic political resistance to its policies—especially the money-printing of QE, which is increasingly recognized as the engine of rising income inequality.
For this reason, large-scale money-printing is off the table. Since the Fed is no longer issuing new money in size into the global economy, demand for dollars can exceed supply, which is precisely what has happened.
As for interest rates: domestically, the Fed is under pressure to “normalize” interest rates, i.e. let them slowly rise to levels that the market judges are aligned with the economy, as opposed to the Fed manipulating rates lower with bond-buying QE programs.
Put another way: if the U.S. economy is doing so great, why does the Fed need to keep its Fed Funds Rate at 0% after six years of financial repression? The Fed can’t have it both ways: it can’t claim the economy is growing at a healthy clip and then insist on keeping rates at 0% because the “recovery” is fragile.
Consider the FX/global consequences of ending QE and talking about interest rates clicking higher: both are extraordinarily dollar-positive, especially when every other major central bank is printing money and expanding credit like there’s no tomorrow.
The USD Strengthens in Crisis/Uncertainty
If we look at happened in the last Global Financial Meltdown of 2008/09, we find the dollar strengthened considerably.
Why? The basic answer is: flight to safety. In a world where assets are suddenly going bidless, i.e. there are no buyers at any price, U.S. Treasury bond market remained liquid: sellers could be assured there would be buyers for their T-bills, no matter how large the transaction. And behind the scenes sits the Federal Reserve, ready to create whatever liquidity is needed by extending credit to foreign banks and by buying bonds itself.
This liquidity fuels a self-reinforcing feedback loop. As demand for the safe haven of dollars and Treasury bonds increases, the dollar strengthens, in effect devaluing the assets held in all other currencies (except those pegged to the USD such as the Chinese RMB).
In other words, the real yield on any income-generating asset must include the foreign-exchange loss/gain. An investor earning 10% in a currency that's losing 20% annually against the USD is losing 10% annually measured in USD, despite the apparent healthy nominal yield.
An investor earning 1% in a currency that's appreciating 10% annually against other major trading currencies is earning a yield of 11%. Since last June, that currency has been the U.S. dollar, which has soared 17%. Never mind the low yield on Treasury bonds; by exiting weakening currencies and buying bonds denominated in USD, even a nominally low 1% bond yield translates into a 21% gain when we factor in the currencies that have lost 20% against the USD.
In crisis, or simply extended periods of uncertainty, what's scarce globally is real yield in an appreciating currency, and right now the only major trading currency that's appreciating is the U.S. dollar for all the reasons noted above. Any nominal yield on bonds issued in euros or yen turns into a loss when measured in U.S. dollars. Even the Chinese renminbi, which is pegged to the U.S. dollar, has slipped against the dollar as Chinese authorities have responded to the devaluation of the Japanese yen and other Asian-exporter currencies.
One result of the global scarcity of real yield is high demand for U.S. Treasuries. High demand pushes bond yields down, effectively replacing the Fed's quantitative easing (QE) bond-buying programs, which the Fed ended last year.
Shrinking Deficits Strengthens USD
Another factor pushing the dollar higher is the reduced issuance of new Treasury bonds as the U.S. fiscal deficit declines. This effectively reduces the supply of dollars as demand increases—the classic recipe for higher prices for what’s in demand.
The collapse of oil prices has another consequence: it’s reducing the U.S. trade deficit significantly, as those 5+ million barrels a day of imported oil now cost a lot less (even figuring in hedging contracts).
This reduces the quantity of dollars flowing overseas to buy goods, adding fuel to the dollar’s rise by further reducing supply.
Add in the $9 trillion in dollar-denominated loans that must be serviced (or paid off) in dollars in the global economy, and you have self-reinforcing dynamics pushing the dollar ever higher as supply is reduced and demand soars.
I've marked up two charts to help illustrate the potential for further gains in the USD. Note that the USD broke out of a multi-year wedge/triangle. This is bullish; there is no other plausible technical interpretation.
The second chart is my projection going forward: the USD is in a classic A-B-C pattern, in which the first leg up is the A leg. The inevitable retrace to support below (either 90 or 85) is the B leg, and the C leg up is typically twice the move of the A leg. This targets 110 and then 120, which was the peak in 2000-2002.
Another retrace would likely occur, and then the USD could make another move higher as the alternative global currencies are crushed (yen, renminbi, euro).
So how do small-scale investors profit from the rise in the USD? One etf that tracks the USD is UUP; another is USDU. I find UUP has higher volume and less volatility, but it does require another tax form at year-end, as it is structured differently from a conventional stock mutual fund that pays dividends. This is a relatively modest hassle for gaining exposure to the appreciation of the USD.
Sophisticated investors can buy futures contracts or speculate on currency pairs. It's also possible to buy options on etfs based on other currencies, for example, the XEU for the euro.
There are also many leveraged etfs on currencies, for example, the amusingly titled bullish Aussie dollar fund, GDAY, and its bearish alternate, CROC.
If the USD does track a classic A-B-C pattern uptrend, the impending retrace B leg may offer an attractive entry to long-dollar positions. The positions could then be exited at the top of the C leg around 110-120, as another retrace would then become likely. This simple "buy the dip and sell the top" strategy could yield gains for years to come, even as other asset classes are being whipsawed or decimated by global recession and instability.
Summary of the Blog This Past Week
Greece: Are You Finally Ready to Do the Right Thing and Leave the Euro? 2/6/2015
The Lesson of Greece: Only Collapse Makes Real Change Possible 2/5/2015
The USD Bull in the Global China Shop 2/4/2015
Rates Don't Matter--Liquidity Matters 2/3/2015
Greece Just Blew Up the Empire's Death Star of Debt 2/2/2015
Best Thing That Happened To Me This Week
My chicken-pumpkin curry turned out well and fed the household for a few meals. Huzzah for coconut cream/milk and tumeric....
Market Musings: Natural Gas
If there is any resource that is seemingly in permanent oversupply in North America, it's natural gas, which has been absolutely crushed in price.
Technical analysis seeks to identify the point when trends are poised to reverse, and one pattern that TA types look for is a falling wedge in a downtrend, which is very bullish, and a rising wedge in an uptrend, which is very bearish.
The chart for natty gas is displaying a classic falling wedge. While analysts and pundits are confident natural gas will keep falling for a long time to come, the chart is suggesting selling is approaching exhaustion and buyers are scarce. As my old boss used to say, the risk has been mostly wrung out of natty at this level, and the next surprise could well be an unexpected decline in supply or increase in demand that pushes prices higher. This would trigger short-covering by all those speculators who are confident natty is heading to $2.00. The ensuing short-covering rally could startle complacent natty bears and reward the few remaining bulls.
From Left Field
How Did Politics Get So Personal? -- no middle ground left, and ideologies becoming more brittle?
What the Sharing Economy Takes: The sales pitch that accompanies this revolution is an update of what Richard Barbrook and Andy Cameron, writing almost twenty years ago, called the “Californian Ideology,” a “new faith [that] emerged from a bizarre fusion of the cultural bohemianism of San Francisco with the hi-tech industries of Silicon Valley…. [T]he Californian Ideology,” they added, “promiscuously combines the free-wheeling spirit of the hippies and the entrepreneurial zeal of the yuppies”—a marriage sealed by a common anti-statism. Its promise was that, in time, everyone will be “hip and rich.”
The sharing economy evokes a fantasy of community in an atomized population." -- Northern Calif. is currently living off this fantasy...
Pay To Play Scandal Just Part of Higher Ed Fraud (By Professor Doom)
Hillary Clinton: The intellectual bankruptcy of the Democratic Party is nowhere more evident than in the looming presidential candidacy of Hillary Rodham Clinton.
Yet the centrists turn out to be at least as ideologically driven as the zealots they deplore. The core of their ideology is the belief that the US has a uniquely necessary role to play in leading the world towards an inevitably democratic (and implicitly capitalist) future. The process is foreordained but can be helped along through neoliberal policy choices. This muddle of determinism and freedom is a secular residue of providentialist teleology, held with as much religious fervour and as little regard for contrary evidence as other dogmatic faiths derided by self-styled liberal pragmatists. -- High-brow Brits take an intellectual sledgehammer to Hilary and the Democratic Party...
Thanks Obamacare: Healthcare Is What Americans Spent The Most Money On In Q4 -- no cost controls in Obamacare, just the "wealthy" paying for overpriced healthcare for everyone else....
21 Parenting tips -- sit apart on the plane -- we just sat behind a set of parents that switched off taking care of the kids--it's practical, sharing the duties....
San Francisco’s Tenderloin Resists New Money Invasion (via Joel M.) -- S.F. real estate is a bubble, but an as-yet unrecognized bubble...
In China, highly educated women are mocked as a sexless “third gender" -- women with higher status and income than hubby are a threat in traditional societies....
No Smoke, No Mirrors: The Dutch Pension Plan (via Paul C.) -- with a bit of transparency, truth and discipline, pensions could be funded properly....
Record Number Of Britons Are Using Food Banks (via Joel M.) end-game of financialized economies cannot be pretty...
"Survival' shoplifting soars as people battle to cope with brutal cuts in austerity Britain -- weakening currencies make imports more costly....
Safest cities in the world: Tokyo named the world's safest city in 2015 Safe Cities Index
The Upper Middle Class Is Ruining America -- worth a read; the upper-middle class is well-off because it maintains the most anti-competitive fiefdoms...
Wealthy Chinese Are Fleeing the Country Like Mad (via maoxian) -- a trillion here, a trillion there and pretty soon you're talking real money leaving China for good...
"Many a book is like a key to unknown chambers within the castle of one's own self." Franz Kafka
Thanks for reading--
charles |
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