U.S. Dollar Signaling a Changing Tide?

The Fed cut the fed funds rate to 2% and curiously said "It will be necessary to continue to monitor inflation developments carefully." Heh heh. One could argue if the Fed were really monitoring inflation, rates would not have been cut (yet again) in the first place. That said, of course the markets loved it and the U.S. dollar has actually strengthened this week. The talking heads in the media are now cautioning commodity inflation will fall as the U.S. dollar continues to strengthen in the weeks and months ahead. Is the tide changing or is this simply another financial head fake?

I've gotten a few emails recently about gold falling from $1000 to $850 and the drop in oil prices and asking if I was changing my investment advice. Was I still bullish on energy, precious metals and commodities? Short answer - you betcha.

First let me say that dollar hedges [MERKX, PSAFX], gold and precious metals (streetTracks Gold ETF (GLD), iShares Silver Trust (SLV), VGPMX), and commodity plays (DB Commodity ETF (DBC)) should not be more than 5-15% of a "normal" investor's portfolio. The exposure thus provided is an insurance policy against both a falling US dollar and rising inflation. These investments, in general, will decline when the U.S. dollar strengthens. However, don't be frightened into selling these investments because, overall, not much has changed.

I find it rather amusing the U.S. dollar strengthened this week as the Fed cut rates in the face of rising inflation. I believe, as does Axel Merk, that the Fed is intentionally supporting inflation as the lesser of evils in its fight against financial turbulence and a slowing economy. Structurally, however, not much as changed. Sure, exports have picked up, but still the U.S. government's huge fiscal deficit, combined with a trade deficit exacerbated by high oil prices, are facts that won't go away regardless of Fed action. U.S. tax and energy policies are so far off base that neither deficit will improve for a long, long time.

Big oil has reported and the earnings results were stellar even considering Exxon's "miss". Exxon increased its dividend but not enough to keep me off their backs. Overall, the theme of big oil's earnings reports was flat production, upstream strength, and downstream pressure. Record high oil prices continued to favor upstream operations and those companies with more oil production and less oil refining (Occidental Petroleum (OXY) for instance). Crack margins essentially evaporated as high crude oil prices, slowing U.S. gasoline demand and the ill-advised ethanol policy have actually, despite McCain and Clinton's election year antics, kept gasoline prices lower than they otherwise would be. If driving season gasoline demand picks up, gasoline could easily hit $4 a gallon this summer.

As far as oil prices dropping, is a drop from $119 to $113 really that big a deal? I mean oil prices are still ONE HUNDRED AND THIRTEEN dollars a barrel. Could oil decline further, perhaps even under $100/barrel? Well, of course it could. Does that mean it's time to bail on energy investments? Of course not. Oil field depletion is still a ~5% fact in Alaska, Mexico, the North Sea, and some of Saudi Arabia's largest oil fields. Worldwide production has to find roughly 4 million barrels a day per year in NEW production just to keep up with depletion rates.

Then we have to take into account demand growth in China, India, Russia, and the Middle East. Iraq continues to be the biggest opportunity around, but as Chevron's (CVX) CEO Dave O'Reilly recently pointed out, there remains two large hurdles for setting up operations in Iraq: 1) security and 2) ironclad contract agreements. Meanwhile, there is no comprehensive U.S. energy policy. Given these realities, and considering that the U.S. is the largest consumer and importer of oil, how can this possibly be bullish for the U.S. dollar or bearish for energy investments? Ain't happening.

As far as gold goes, we have certainly seen a pretty good hair-cut. Time to get out? Nope, time for folks who don't have a position in gold to obtain one. Kitco.com and APMEX.com are awaiting your orders. Gold moves very quickly in both directions. Though the uptrend was arguably broken, it wouldn't take much in the way of world events or inflation upticks to resume what I believe is a long term climb. Investors with positions in gold should hang in there and be patient.

With respect to commodities, I am a bit less confident simply because it's not my game, so-to-speak. I still maintain that the Bush administration's ethanol policy is one of their worst policies (and that is saying something) and should be stopped sooner rather than later. Food inflation should then slow as we stop using corn to power our SUVs. Yes, gasoline prices will go up, but they should go up. Perhaps that will prod Congress to adopt a real energy policy, but I won't hold my breath, and neither should you. That said, I do agree with Bush that the time has come to open up ANWR and the outer continental shelf to oil production. They can drill offshore in Norway, Denmark, and the UK, but not the U.S.? This doesn't make sense.

Considering the huge oil bind we are in, and the long lead times to get these resources on-line (7-10 years), the U.S. had better get on the stick with these projects now. By the way, the U.S. government, like governments all around the world, should get its fair share of the oil royalties. This money should be funneled directly into alternative energy based mass transit, tax incentives for solar and wind investments, nuclear energy development, and high mpg alternative auto transportation tax breaks.

Meantime, stick with your energy investments for the long run. They will power your investment returns and protect you from a falling U.S. dollar and rising inflation, both of which, in my humble opinion, will continue the trend of the past few years.

Disclosure: The author is long DBC and VGPMX.

Comments

[User 181945]

Our energy "policy?!" really leaves one to wonder. In the 1970s Carter signed a treaty with Cuba dividing the Straits of Florida. There was a recent large oil field discovery there and China signed a drilling contract with Cuba. They are drilling in these waters, but we are precluded from doing so because of environmental regs about drilling off the Continental Shelf.HUH?

[richjoy]

Mr. Fitzsimmons said it better than I could...his ONLY mistake might have been in saying "the Fed is INTENTIONALLY supporting inflation...". I would have preferred he had said the Fed's policies RISK supporting inflation in the making its priority that of fighting financial turbulance. (A small point perhaps, but important to many.)

[sbenard]

The only thing I would add here is that the price of oil Friday reached nearly $117/barrel. We're already up substantially off the lows reached just a few days ago. Even a surging Dollar didn't help. I suppose this helps to reinforce the author's point.

[Cicero]

Congress allows the Fed cartel of independent private bankers to create money from nothing and then charges you and me 8% of our national budget in perpetual interest for the privilege (we never repay the principle).
The NY Times article “The Nixon Recovery” of 2/4/04 admits they print or don't print money to sway elections, causing runaway inflation (as in the 70's): ( query.nytimes.com/gst/fullpage.html?res=...
The NY Time, article, The Education of Ben Bernanke admits the Fed created the housing bubble by pumping easy money in an effort to stem the damage of the dot.com bubble (that they fueled with easy money in the 90’s): www.nytimes.com/2008/01/20/magazine/20Be...
It notes the Fed “…has vast powers over the economy” with its “…control over the supply of money” and that this “…power to expand the money supply is unique... only the…Fed can create new money.” It notes Bernanke helped create the housing bubble and that the Fed ignored the warnings (of people like Ron Paul) and “the speculative lending continued.”
The same article notes the Fed flooded the economy with easy money specifically to manipulate the 72 election for Nixon, creating the “brutal recession” and massive double digit inflation that marked the economic havoc of that decade. We learn that idle builders (my father was a carpenter) “were so enraged that some sent him two-by-fours in the mail.”
Bernanke admits Fed caused depression in the conclusion of this 2002 Speech here on Fed Website: www.federalreserve.gov/BOARDDOCS/SPEECHE...
Bernanke admits creating money from nothing in a speech on 11/21/02 on the Fed’s website: www.federalreserve.gov/boarddocs/speeche... / (4th paragraph under heading “Curing Deflation.” He duplicitous states the US gov’t creates it – is so, why pay independent private bankers interest? In fact, Congress allows the “Federal Reserve” (they aren’t federal and there are no reserves) to print monopoly “money” and loan it to the fedgov. We, the sheeple, pay 8% of our national budget in perpetual interest on that “money”. Talk about an investment! Imagine spending $3,000 to print a million back in 1960, lending it to the fedgov, and collecting 3% “interest only” for life. That’s $30,000 a year for perpetuity – a 1000% return on investment each and every year for perpetuity without investing another dime.
Ron Paul anyone?

[User 30121]

Michael, Michael, Michael don't you know its not politically correct to speaketh truth, particularly when the truths are exposing our government as the culprit causing all our problems! Oh, well then. KEEP DOING IT-PLEASE!!!!!!!!

[bearfund]

Cicero, it's not time yet. Someone like Dr. Paul will be elected, but only when the people realise they have no alternative but starvation and death. Most Americans are too stupid to even know what monetary policy is, much less why they should care. All they know is that they like consuming and the talking heads tell them that "stimulus rebates" and interest rate cuts "help consumers" so let's please have more of both. The whole system is set up to enable them to consume more than they produce, and, ignorant or not, they'll all complicit in it.

After the dollar collapse (and there WILL be a dollar collapse - Americans lack the will to do what's required to avert it), there probably won't be any candidates talking about their support for the gold standard. It won't really be a choice - if Americans want oil or copper or rice or tungsten or timber or kiwis or euros or Shenzhen shares, they'll have to pay in gold. You don't seriously think you get to default on 50% of global GDP worth of debt and keep spending and borrowing in that currency, do you? All that will be left to sort out are the role of silver and the arbitrary number of "dollars" one assigns to an ounce of either. What will happen to the hundreds of millions of Americans with negative net worth relying on their tax-deferred shares and government borrowing to see them through their twilight years is anyone's guess. It's not going to be pretty, but it will be richly deserved. Those of us holding gold, silver, oil, food, NOK, CHF, and short Treasury positions will do fine. Indeed, my greatest hope is that the collapse happens soon enough that I will have the opportunity to help rebuild the classical American republic out of the dead and rotting corpse of today's vacuous, illiberal empire of consumption and confiscation. Until then, Ron Paul and the few others like him remind us that there is reason for hope, however distant and dim it may seem.

In the meantime, ignore Mr. Fitzsimmons's advice to have "5-15%" of your portfolio in commodities. We'll assume for the moment that you're sane and place you into one of two groups: consumer-culture bulls, who think it will take centuries more to complete a very slow collapse, and bears, who think it could happen within our lifetimes, perhaps sooner and more explosively than anyone expects.

If you're a consumer bull, your portfolio should be conservative. Perhaps weight gold, oil, and food somewhere near 30%, with another 20% in strong currencies with moderate yields. I like NOK especially but a mix is a wise choice; avoid high-yield risks like ISK and carry-susceptible low yielders like JPY and CHF. You're not looking for big gains or fat yields, just currencies that will pay you something while the dollar slowly and fitfully declines further against them. The balance should be in multinationals with broad currency exposure that make essential products and pay reliable dividends, with perhaps a sprinkling of domestic growth opportunities like bankruptcy advisors, auctioneers, repo outfits, and collection agencies.

If, however, you're bearish on consumption, there's little reason to be so conservative: 75% commodities, 25% foreign cash and short-term bonds, 20% equities, and -20% Treasuries is a smart mix. If you're really bearish and can tolerate the volatility, don't bother with equities at all. Sell off part of your commodity positions on the obvious spikes to keep your portfolio in balance, and use the cash to jump on occasional growth opportunities in developing country equities. Physical gold and silver should be accumulated during corrections and never sold (you're going to need it, right?). Cover some of your Treasury shorts when yields are unusually high or when the dollar undergoes a major devaluation; add to them when the dollar is stronger or yields are unusually high, as they are now. If your horizon is sufficiently distant, this portfolio is a sure winner. All it depends on is American profligacy, ignorance, and arrogance.

Those of you on the other side of these trades, you're neither bull nor bear but ostrich. I hope to see you begging someone to take the plasma TV you put on your long-gone credit card for a loaf of bread and the SUV you're upside-down on for a cord of wood. So long, and thanks for all the wealth.

[The Fitzman]

bearfund: i think i should correct a wrong impression i may have left with some readers: when i said:

"First let me say that dollar hedges [MERKX, PSAFX], gold and precious metals (streetTracks Gold ETF (GLD), iShares Silver Trust (SLV), VGPMX), and commodity plays (DB Commodity ETF (DBC)) should not be more than 5-15% of a "normal" investor's portfolio."

i should have pointed out that i don't consider energy and energy services stocks as a straight "commodity play" the same way i DO consider DBC or corn futures or oil futures a straight commodity play. if you are lumping energy and energy services into "commodities", which i suppose could make sense, than the figures i would recommend would be closer to 65-80%. hopefully, those you have read me consisently know i am a firm believer in peak oil, and that i continue to believe that energy and in particular energy service companies are the single best investment choice in the current environment, and will be for years to come - at least until the proverbial shit hits the fan. you'll want to be early on the exit. however, it's too early to sell energy related stocks and mutual funds as there is a bunch of money to be made there over the coming years. and, i dare say, i believe more to be made in energy than in gold or silver or corn futures. also, i disagree with your 20% in treasuries, that's just dead money. safe, but still dead.

[poet1]

Money to be made: energy, gold/slv, food. What about for ex: V visa? Not really repo or collections, but it goes with teh program.

[Kunst]

A real energy policy would include a crash program to reduce US energy use, both short and long-term. We can't continue to consume 1/4 of the world's petroleum production. Either we reduce our own use or we will find ourselves priced out of the market and forced to make radical changes in our lifestyles due to oil shortages. There is no way we can ever balance our trade deficit with our current level of oil consumption.

Do you hear any of the presidential candidates talking about this?

[Learning Curve]

And, Kunst, a real energy policy would be based on an honest analysis of our situation and would be in keeping with an oath of office to be responsible to American citizens. Instead, a secret meeting (the secret kept safe by the Supreme Court) attended by people thinking only of their immediate self interest is a big part of our ensuing problems. We, as voting Americans, were not allowed any input or insight into the decision process. It takes very little thinking to understand why the oil men (and woman) continue in their depredations on the world.

[PAW]

Bearfund - sounds like you have read some Ayn Rand. You are correct - the day of reckoning will come.

[CT Programmer]

If bearfund is correct, then you should sell all your positions, build a shelter in the ground, and stock up on canned goods and ammo. And maybe one of those cool leather jackets that Mad Max wore ;-)

[deutschefach]

The ending of the gold standard was the end of prosperity in the United States. What a crude joke. Good Money leaves when bad money appears. The flight from our currency into other vehicles can be traced to that fateful decision. Without a similar standard, all currencies world-wide will be subject to becoming commodities. The people of the world will be dragged by the large scale movement of cash from continent to continent.
Warren Buffet said Americans should think small. He is shorting US positions and going long in China, India and the Persian Gulf ring.

America does not have leverage. It is a debtor nation. Leverage is when you use other people's money to accomplish something. Without value in the Dollar as a home currency, leverage will be afforded to the most stable currencies. That is why the Sterling and Euro are kicking butt.

The American banking system is very much at risk of loosing its attraction to foreign investors seeking alternatives. If the European Banks move to compete with increasingly rich Chinese and South-East Asian banks, the center could shift. Such a move would be similar to Global Warming in reverse: America freezing. Without the influx of outside capital into the American Banking system from Saudia Arabia, Dubai et al the US would be hitting a full stop.

This rich economies will soon come into the US markets looking for bargains in Commercial Real Estate. They will dictate price and terms.

To think that at the end of the Clinton presidency the economy was solid but no more. Global Business practice is shrinking the middle class and forcing them downward into poverty.

Innovation and a war like change in priorities is needed to focus America's energy. What is going on now is a joke. The way the Fed is managing this phase shows they do not have a long-term plan.

[Lou Thomas]

Other than precious metals, almost nobody holds actual commodities and waits for them to appreciate. Instead, they place bets on future prices using derivative contracts. And such bets involve counterparty risk.

The present environment is practically screaming with counterparty risk. For a conservative investor, non-dollar sovereign debt would seem to provide a better hedge against the dollar's decline. So, the 80 percent the author says in his comment should go to currency hedges and commodities combined I would say should go straight to the (non-derivative-based) dollar hedges themselves (sans commodities) if one is worried about such risks.

[Lou Thomas]

Oh, and bearfund has a bad attitude. It's one thing to think you are right, but quite another to gloat over everyone else's imagined misfortune. The great mass of people did not create this crisis, even though they may be ignorant of its causes. It was created by an elite investing class that has a lot more in common with you than it does with them, and when they figure out what has happened, they will regard you accordingly.

When the hard times hit, you will need other people more than ever, and whether you know it or not, you need them even now.

[changeitordrownit]

...and condoms...you multi-colored rabbits.