As the Dollar Continues to Collapse, Where Will You Put Your Money?

This piece follows a previous article, in which I warned against shorting equities -- despite the fact that I believe the stock market is going to fall dramatically, at least in real terms (which I'll again expand upon later). As usual, my cautious outlook prompted a flurry of emails from readers asking what they should be doing with their money in order to prepare for the impending firestorm of rising prices that will derive from the inflationary printing and unprecedented credit-easing governments worldwide are foisting on their citizens.

It's important to note that, although I refer to "the" collapse of the dollar and Treasuries, these events are not going to happen in one minute, or one day, or even one week. Indeed, since I started writing about this scenario in December, the government has done so much to try to reverse the course of this trend, and yet the cracks have widened, and the dollar and Treasuries continue their inexorable march downward. Even though I don't believe, however, there will be any particular event that will trigger the collapse, I do believe it will accelerate with time -- ultimately exploding in a quick, catastrophic climax.

I am forever an analyst, but I am no longer an adviser or manager, and I want to encourage anyone investing money to do a prodigious amount of research before committing funds to anything – especially in this environment. Having said that, the best and safest place to start discussing my own opinions about capital allocation is to reiterate what you shouldn't be investing in: stocks, Treasuries, and dollars. As I said in my last article, although the stock market may trade sideways or even go higher from here, once the consequences of the unparalleled governmental printing spree and credit-easing of the last few years finally do hit the economy, earnings and dividends growth -- which are the main drivers of stocks – will never be able to keep pace with the inevitable and substantial inflationary price increases in the general economy.

This highlights what I consider to be the most dangerous part of this environment: your portfolio will appear to be going higher, but in real terms, you'll be losing money – on a scale greater than, I believe, even that of the 1929 to 1932 collapse. The only thing I can imagine worse than watching the market fall the 90% or so that it did 80 years ago is watching a stock market rise in a period in which it is vastly underperforming inflationary price explosions. The drop from 1929 to 1932 may have been painful, but at least it was an honest market.

So where do you go to survive, or even to outperform?

SHORTING THE DOLLAR INDEX?

The dollar index is merely a gauge of the dollar against a handful of the rest of the world's major currencies – leading to a general misperception that I call "currency relativity." Unfortunately, the fact is that every other central bank on earth is employing the same quantitative easing principles as the U.S., and so their currencies are equally doomed. If you short the dollar index, you are merely taking a position that the dollar is going to be weak relative to other major currencies, and that probably isn't going to be the case; they're all trapped in the same burning house.

On a related note, you may want to pay attention to the fact that Treasuries and gold seem to be decoupling from their heretofore nearly direct inverse relationship with equities. What does this mean? Mainly, in my eyes, it decries the old notion that, just because the stock market goes down, people will run to Treasuries as a safe haven; apparently the so-called "risk-free" rate of return isn't so risk-free anymore. Likewise, it would seem that, just because the stock market is going up, people aren't necessarily dumping gold. And this lends credence to my theory that investors not only expect inflationary pressures to drive stocks higher in nominal terms (but not real terms), but also that, in order to really survive rising prices, gold is one of the best places to be.

REAL ESTATE?

Have we hit the bottom, and are prices going to rebound from here? My best guess is that, again in nominal terms, we are near a "bottom," but as with the stock market, what does that mean? Yes, housing prices might rebound, but will those prices outperform inflationary pressure in the entire economy? Probably not. I will say this, however: when rates and prices are shooting skyward, having a personal residence with a relatively low interest-rate fixed-rate mortgage is a great position to be in – assuming you have a job, and you are going to be able to keep it. First, there's the tax deduction on the mortgage interest. But more importantly, a fixed-rate is just that: fixed. Even as all other prices and rates move higher, the mortgage payment doesn't – making it a progressively smaller part of a household budget.

To illustrate the way fixed-rate mortgages work with inflationary trends, think about the house your parents or grandparents bought for $20,000 several decades ago. Their monthly payment remained fixed at around $200 per month for thirty years, and yet their wages undoubtedly increased dramatically in that time. At the beginning, $200 was likely a hefty part of their budget, but toward the end, it was probably insignificant. Now, imagine how much that effect would be amplified by a hyper-inflationary economy – which, unfortunately, our government has all but guaranteed in the coming years. Remember, we all have to live somewhere, and if part of your cost of domicile is going toward equity, and the interest you're paying is fixed -- in an environment of rising rates and prices -- well, I guess it doesn't get much better than that. The alternative is to rent -- and leases escalate with inflationary surges.

In general, however, the reason I believe housing won't outperform inflation is that credit is all but gone; no matter what any of the pundits say on CNBC, the stark reality is that people can't get loans. It doesn't take much to recognize that if the consumer can't borrow, then he can't buy a house. And if that condition has become the status quo – and I believe it has – then what will drive the housing market?

COMMODITIES?

People call me a gold bug. I'm going on the record here -- I am not a gold bug. I am, however, a huge fan of commodities right now -- and gold is hovering near the top of my list. Gold has almost no industrial value, but I follow it anyway, because it is nearly a perfect metric for the anticipation of future inflationary price-increases. Why? Gold has a psychological component that it shares with almost no other thing on earth -- it literally packs eons of historical consistency and value; people have always been passionate about gold, and it has unfailingly been the ultimate measure of economic and financial stability. As such, when people are frightened, they fly to the one thing that embodies that stability in order to protect wealth, and this means that gold will react to inflation faster and more accurately than just about anything else.

Further, its overall popularity means it is more liquid than other scarce metals and stones. All of these variables come together to convince me that, when the bottom falls out of the dollar and Treasuries, not only will gold keep up with prices, but it will outperform as people flock to its empirical safety. Remember: during a panic, everything tends to overshoot intrinsic value, to the upside and to the downside. Gold's universal nature will undoubtedly put it at the head of the pack, all but guaranteeing an above-average rate of return – at least until everything stabilizes. Unfortunately, however, I think we are sitting on the cusp of a colossal crisis, the likes of which we've never seen. At this point, economic stabilization seems like little more than a distant dream.

For many of the same reasons I like gold, I also like oil and agriculture. Let's face it -- getting a loan these days is almost impossible for anyone, and farmers and oil-producers are no exceptions to this troubling rule. Yes, I understand a slowing economy means slowing demand for commodities. But demand for food and oil will not simply cease; 2 billion Chinese and Indians may not be buying at the Gap (GPS) this season, but they aren't about to stop driving and eating. So -- unlike gold -- oil and agriculture do have practical aspects to their demand that ensure more than a mere "safe store of wealth." As currencies falter, prices of oil and agriculture will keep pace; the fact that producers in these industries can't borrow should limit supply in a world in which demand probably won't fall all that significantly – relative to everything else. All this will almost certainly equate to better-than-average performance.

SHORTING TREASURIES?

Shorting long-term Treasuries at this moment may be my favorite investment of all time. I love how the Fed commits to buying $300 billion worth of 10- to 30-year Treasuries in order to keep down the long end of the yield curve, and yet those rates go up anyway. This is just more evidence that the United States government is rapidly losing its ability to manipulate the economy, as well as further testimony that now is the time to bet against the Fed, and to bet against it big. I know, I know, I'm a doomsday prophet and a conspiracy theorist. Believe me, I've heard it all. Try to remember, though -- if you can see through that fog of skepticism and doubt -- that people were also ridiculed for predicting the failures of the Roman, British, and Soviet empires. And yes, you are correct -- anyone can make a general prediction, but timing is everything.

Let me be clear on this point, however: I am not making a vague prediction; I am predicting, specifically, that the dollar is going to weaken to the point of collapse – along with many other global currencies, and that it's going to happen sometime in the next two years (probably sooner). Try to bear in mind that the U.S. has committed itself to almost $13 trillion just to battle this financial crisis alone, and that figure is 50% more than the government has spent on every single project, war, or undertaking since the country's inception, in real dollars -- combined.

Despite what you may or may not believe about my prediction, shorting long-end Treasuries continues to be a no-lose proposition. If by some miracle, the Fed manages to pull some proverbial rabbit out of its hat and fix this incomprehensible mess, then part of its solution, ipso facto, will necessarily be raising rates to maintain the integrity of the dollar. On the other hand, if my prediction is correct and the dollar fails, well, Treasuries are going to follow it all the way down. Yields have been hovering near all-time lows for months. There's no place to go but up.

HOW DO YOU GET INVOLVED?

The obvious and inevitable question is: what vehicles offer the easiest and most practical way to participate in some of these moves? Until recently, the only way the average investor could profit from such events was to use futures contracts or to take physical positions, both of which are cumbersome, complicated, and involve a great deal of maintenance. Fortunately, however, times have changed. In recent years, many companies have introduced exchange traded funds (ETFs), some of which even offer two- or three-times leverage. There are a lot of them out there, and I again encourage you to do thorough research before diving headfirst into any investment vehicle. In my own portfolio, I am using some of these ETFs, which I have disclosed below.

Disclosures: Paco is long TBT, UGL, and DXO. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies.

Comments

[fireball]

gold and silver look best. farm land seems a decent prospect. at least when you awake in the morning those things are still there. the only currency that interests me is the guernsey pound if it is true that it is still gold backed. maybe australian dollars or canadian will hold out for awhile. my gut tells me to stay away from asian currencies. i have no intention of seeking safe harbor in any fiat currency. it seems best to trade lightly for now. take what you can from the market and wait for another drop. then ag, mining, and oil, maybe. have to re-evaluate when that time comes.
the false value of paper got us here. i don't think it will get us out. i have to agree with christletoe to an extent. be ready to help. the very wealthy will probably stay ahead of the curve and end up very powerful. in the end that is their goal.

2009 May 25 08:53 AM

[User 305589]

never underestimate neither the resolve nor the capabilities of the FED! I agree with your analysis 99% over the long term, but you are imho dead wrong assuming that the fed has already lost the power to manipulate interest rates across the entire yield curve. They will continue to buy ever increasing amounts of long treasuries. Coupled with falling inflation and once again rising DEFLATION fears nominal yields will get a lot lower, temporary, before they get much higher. Shorting treasuries has become popular, but imho these shorts are in for a nasty surprise. The long bond will very likely make another new all time high - his proverbial swan song - and then start a relentless decline.

2009 May 25 08:58 AM

[D. McHattie]

Well, you still didn't really tell us what we should be doing with our money.

But having much of my money in GDX, DAG, PBW, HL and CCJ, I found your article very comforting.

2009 May 25 09:10 AM

[Bill Jencks]

Paco,
A good honest article....The only thing I would question and disagree with is your advice investing in such things as paper gold through EFTs. I see absolutely no point at all in investing in dollar denominated EFTs since, as you say, the dollar is going to fall -- so even if gold does goes up in value , you will lose all your gain through dollar devaluation when you cash out into dollars.

Secondly, not many people are aware that, about three weeks ago, the NYSE-Liffre futures exchange defaulted on its deliveries of 1Kg gold bars. Read it here:

www.marketskeptics.com...

www.marketskeptics.com...

www.marketskeptics.com...

Stay well away from dollar denominated stocks, the dollar and all EFTs.

Buy gold that you can hold.

2009 May 25 09:11 AM

[WACG]

People that make extreme predictions are usually extremely wrong. But have fun and thanks for playing!

2009 May 25 09:16 AM

[cameroni]

Nice article,

But lets not hit the panic button on the US Dollar too hard just yet. The whole globe is invested in it in a very big way. Worries that creditors will start pulling out the rug from under us and forcing a major sell-off of all things American and debt related are truly overblown. A true dollar failure would have extreme and devastating global implications. I do not think for a moment that the biggest creditors are all about to shoot themselves in the feet on this one. They may be dismayed by what they are seeing with QE but at the end of the day most Governments want stability in financial markets and they will cooperate with the dollar devaluation because it is actually in everyones best interest (the lesser evil).

Every Government will take a loss on this one but it is better than the alternative of a total dollar failure. I follow the dire warnings being issued by Peter Schiff and others and while the message is convincing it is still a prediction and for him and others, a simple marketing tool to build business through fear. I listen, I take it with a grain of salt, and then I do my own thinking.

Let's not lose all faith and write the US off so quickly. Caution is the byword of the day but "it ain't over till the fat lady sings".

Cam

2009 May 25 09:50 AM

[cynewulf]

Oil stocks are the best. Especially tar sands like Suncor, Petro -canada ,Encana,etc.. The earnings are much better then in gold stocks and then there is the bonus of the peak oil dilemma which will drive companies with higher priced, but large reserves, well, much higher. The tar sands is where the future lies,long before windmills and solar panels, both of which cost way more then dirty oil. Don't listen to the politicians. They are just pandering for votes,from some of the roughest and stupidest members of society. It is a dirty world and it will get dirtier.

2009 May 25 10:07 AM

[HATEFEEBAY]

For disclosure I hold SLW (Silver stock), AGQ (double silver ETF), PTR (Chinese Oil Co.). I had a position in TBT, but sold it within the massive Fed buying which is a manipulated circle jerk. Why ETF's instead of actual silver was asked is this-as silver goes up (and gold for this equation) and the dollar of a value goes down, when you do cash it out you will get equal value so X silver for Y dollar now will get you X silver for 10Y dollar when you cash. For a person like me with $250K in silver, and ETF is a lot easier. If you think society will just completely collapse, forget gold and silver and store lots of ammo, food, water, et cetera and trust me I do NOT think that is a bad idea! I think silver has a lot more upside than gold and if you chart it out, you will quickly see why plus silver has a lot more practical uses over gold in industry. Let's hope we are all wrong and just paranoid, but sadly as a Wharton School Alumni, I fear very bad things ahead that are nearly unspeakable.

2009 May 25 10:52 AM

[Walter L. Zweifler, ASA]

Predicting hyper inflation does not take a genius. Each investor will agree or disagree and adopt a policy which matches their risk aversion and means. Shorting through ETFs have costs to carry which must not be overlooked. Other investors will await higher rates and buy 5 - 10 - 15 year maturities at bottom prices. Some possibiilties: TAXABLE municipals which offer greater current yield or zero coupon municipals of states which are too big to fail - i.e. California. Walter Zweifler, ASA www.zweifler.com

2009 May 25 10:59 AM

[PastTense]

While I agree with much of what the OP has written, to protect oneself I think one needs to have a broader strategy. Specifically I think that certain sectors of the stock market will also well. For example to me it looks like health care reform in the U.S. will end up a compromise extending coverage, but doing almost nothing about exploding costs.

PS. I disagree with chistletoe. The problem being that if things do get that bad, law and order will break down and someone will come along and steal any hard assets and land you possess.

2009 May 25 11:01 AM

[DrPhreak]

> and who have hard assets stockpiled. People who enjoy working and
>
> taking care of the people around them.
> The rich are all doomed. Which is no less and no more than what
> they deserve.

2009 May 25 11:14 AM

[secmaven]

Bank of America stock is the place to go with your capital. The smart money just put 8billion into 800 million newly created shares. If 20% of that had be put in the silver market we would be looking at a double overnight. But the smart money knows where to go, right. So onward and upward with B of A!

2009 May 25 11:15 AM

[Trane250]

Very prescient analysis. However, the dollar is still the world's reserve currency and rather than seeing the world financial system collapse and pax americana fall apart along with the dollar, the creditor nations will step in to save it. They will exact a terrible price for this, perhaps a lien on all U.S. private assets or outright confiscation. Get ready for the new world order.

2009 May 25 11:19 AM

[sunnsea]

Funny. This morning the dollar is at $1.40 to the Euro. Back in June '08 it was trading at $1.60. Where was the panic then? Only complaints were about gasoline over $4.00 a gallon. Could it be because we have Obama as President that suddenly we use words like "collapse", "panic." It was the Bush policies that made sure that we a) did not even know we were in a recession since late 2007, (I knew we were in one but my right-wing friends kept telling me were not) and b) that the dollar should remain weak and we should not even discuss it. Then July 15 everything changed again with speculators out of the oil markets, trying to shore up a Republican victory (obviously that didn't work) to bring back the price of gasoline in America to "reasonable" levels the dollar strengthed against the Euro. By September 15, well, you know the story. Now all of the choice propaganda words are in every article to set the stage for an attempted Repblican coup in 2010. That is the point of all the dire forecasts that you read now.

2009 May 25 12:18 PM

[popey]

Paco, I agree 99%. But again you don't follow through with your logic. A collapsing bond market and social dislocations would suggest physical ownership of hard assets (gold, silver in coin format) and particularly tradable commodities (cases of scotch, and other barter items). Because if you are right, then barter will be big. So people should position themselves to survive in a barter universe.

2009 May 25 12:21 PM

[Windsun33]

The problem with the Armageddon (or Obamageddon) scenarios is that if the dollar becomes totally worthless, the only thing that will be worth holding is guns, booze, food, and cigarettes. And that ain't gonna happen this time around.

Personally, I am thinking more of a Jimmy Carter scenario, in which case almost anything that would cost more in dollars, but less in other currencies would be good. That would include most commodities, real estate (selective), and foreign currencies or foreign currency demoniated stocks/bonds.

2009 May 25 12:53 PM

[MattZN]

For any country with a large middle-class (like us), inflation is not fun but it also works quite well as a relief valve precisely because of the large number of fixed-rate mortgages out there. During the late 70's and early 80's my parents got squeezed like everyone else, but their mortgage payments also went down considerably relative to their wages and we squeaked through.

The FED is clearly counting on refi's by our large middle class to put real money back into the hands of enough people to mitigate the current mess and prevent a depression from occurring. The cash equivalent makes the idiotic bush tax refund look like small ripple in the pond.

-Matt

2009 May 25 01:09 PM

[dcb]

Dollar May Rise Next Week After Overdone Slump, Barclays Says
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By Ye Xie

May 22 (Bloomberg) -- The dollar may rebound after the currency’s 3.7 percent plunge this week against the euro created a “lose-lose situation” for the U.S., Europe and other countries, according to Barclays Capital Inc.

The greenback tumbled this week against all of the 16 most actively traded currencies on concern U.S. creditworthiness deteriorated and near-zero borrowing costs made the nation’s assets less attractive to investors.

“While sentiment has become very negative toward U.S. bonds and the U.S. dollar, this sell-off does not seem to have benefited anyone,” wrote Steven Englander, chief U.S. currency strategist at Barclays, and Aroop Chatterjee, a colleague, in a research note today. “Appreciating regions such as the commodity currencies and euro zone have experienced a backup in bond yields in conjunction with effective monetary policy tightening. This is a lose-lose situation.”

The dollar slid today beyond $1.40 per euro for the first time since January, and its weekly drop was the biggest since the five days ended March 20, the week the Federal Reserve announced its plan to buy up to $300 billion in Treasuries to keep borrowing costs low.

Investors should buy one-week call options on the dollar versus the Swiss franc, which is “vulnerable on any pullback in global fiscal concern,” the New York-based analysts wrote. A call option gives investors the right to buy a currency at an agreed-upon price. The dollar dropped 3.3 percent to 1.0840 francs this week.

This in conjunction with the falling stock markets, should drop commodities and together act to magnify each other creating the sell off we need to go long again. Just my theory.

2009 May 25 01:13 PM

[MMMPARSLEY1]

I am not suggesting anybody do this, but if society brakes down via a dollar debacle or some other scenario; there will be nothing stopping you from growing some nice herb for you and your terrified friends and relatives. If you want, you could even exploit your ability to grow such herb by selling it, pocketing whatever people decide to exchange as a unit of currency.

I don't think that is going to happen - but I don't think the people I know are ready for a man vs. man, woman vs. woman, man vs. child etc. internal warring for an extended period of time. Even if I have to eat the grass in my yard, I probably won't shoot my neighbor for his pinto beans he's been storing in the basement.

2009 May 25 01:21 PM

[tinman]

re " what you shouldn't be investing in: stocks, Treasuries, and dollars" -- you're missing the elephant in the room, bonds. Why would anyone want to hold bonds in an accelerating inflationary environment?

2009 May 25 01:24 PM