Preparing As The USD Nears The Tipping Point

by: Simit Patel

One of the most significant stories to come out this past weekend is the news that Russia and Iran are moving to conduct bilateral trade in Iranian Rial and Russian Ruble instead of the US dollar. Recall that we are also seeing a number of African and Asian countries, including India, opt to conduct more of their international trade using China's Renminbi -- taking away demand for US dollars in the process.

This is how it begins -- "it" being the panic out of US dollars. It starts conversely, with a dollar rally; it's fueled by central banks utilizing substitute currencies and international trade being conducted with substitute currencies, namely China's Renminbi. It starts with a few people quietly moving out of US dollars, but the more that leave, the faster the process accelerates. I'd argue the run on the dollar has been very slowly happening for years now -- as illustrated by a 10-year chart of the US dollar, which shows it declining against most currencies -- though I think we are starting to take bigger steps up the parabolic curve towards a full-blown dollar panic.

In addition to the loss of confidence other big players are showing, actions from the US are not helping. The recently passed National Defense Authorization Act places sanctions on Iran's central bank, and essentially constitutes an attempt to cut Iran off from international trade. From this perspective, Iran's move to conduct bilateral trade with other currencies is a retaliatory step, signaling that economic warfare could increasingly be a part of the military conflict brewing in the Middle East. The US initiative here is sorely misguided, and liable to backfire. Debtor countries are on a slippery slope when they try to dictate which currencies will be used in international trade.

So what's this mean for investing/trading opportunities? A few considerations:

1. Gold. The easiest, safest, and perhaps most lucrative way of playing this is via gold. With that said, not all forms of gold are created equal; ETFs like GLD and other vehicles offering unallocated ownership of gold may suffer from confiscation, price controls and the imposition of new taxes in the wake of price controls; the customers who lost their money in the MF Global fiasco illustrates that this is a very real concern. There is no substitute for bullion you can touch, as well as bullion stored in vaults allocated in your name. GLD, and gold mining stocks like GDX and GDXJ, can be a part of your plan -- but are not the ultimate insurance policy against a hyper-inflationary breakdown.

2. Inverse US dollar ETFs. Directly shorting the US dollar, via ETFs like UDN, are also an option -- though capital controls are sure to emerge in the event of a full-blown panic, in my opinion. As such, short dollar trades should be viewed as a speculative play. I also think they are better implemented via the forex market, and via a non-US broker; such brokers are more likely to be able to escape capital controls that interfere with this trade opportunity.

3. Short US Corporate Bonds. A dollar panic will send interest rates on corporate debt much higher, which should send corporate bond prices down -- in theory. However, in a hyper-inflationary environment, I don't think shorting anything is a particularly good idea.

4. High Dividend Stocks. Blue chip stocks with a high market capitalization, low beta, healthy balance sheets, and strong history of dividends are likely to be the recipient of inflows as investors look to scramble out of dollars and into assets worth owning. Intel (NASDAQ:INTC) is an example of a stock that meets these criteria; its beta is just 1.08, it has a dividend yield of 3.3% at the time of this writing, its market capitalization is currently in excess of $100 billion, and it has over $7 billion in cash and a current ratio over 2.

5. Commodities. The entire commodities sector, which could be played via commodities ETFs like DBC, will rally in an inflationary melt up -- as commodities bring the security that only real, tangible goods can, while also offering exchange value in the event of a true monetary breakdown.

In terms of technicals, the price to watch on gold is still $1620, as I noted before. At that point, we should start seeing more bulls enter gold, which will help further accelerate the dollar exodus. Gold is the centerpiece here; gold, stocks, and commodities will all rise together in a dollar panic. For this reason, the price of gold is especially important to watch, even for those who are not invested in gold.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.