Monday, December 7, 2009

The Dollar, Bernanke and the Golden Goose - Are they Coming Home to Roost?

It is interesting to note the top three headlines on CNBC business news this evening:

‘Why are Investors so Worried about a Stronger US Dollar’

‘Fed will Keep Rates near Zero through 2010’ says Bill Gross


‘Rates to Remain Low’ says Ben Bernanke

Why is it that such mundane speak is making headlines all of a sudden (apologies to our other Bob on the floor)? Well it’s like this: last Friday the dollar had its only significant one-day rally in 6 months and early on Monday the unthinkable happened, i.e. the dollar sustained a rally into a second day, something that has been rather unheard of since last March. This has put the frighteners on many institutional investors, most of whom have made large profits on the back of a weak dollar, and basically on nothing else. If your reason for financial living begins to be questioned or it is beginning to wear thin, you look to your usual suspects - financial leaders like Ben Bernanke and Bill Gross to reaffirm your (albeit fundamentally flawed) strategy and have them undermine the counter view. This is exactly what has happened today although in Gross’ case he was merely putting his own spin on what Bernanke himself had just said. Why rein in the wisdom and direction of a herd when the good shepherd is on your side?

And why the sudden need to pull the rug from under the dollar? The reason is simple – Friday’s jobs report reveals that in November the US shed the lowest number of jobs it has lost in any month since the recession started 2 years ago. The marginal 11k loss caught most analysts by surprise, with even the most conservative data watchers having predicted a job loss of at least 100k. To compound matters, the number of jobs lost in October was revised downwards by a further 80K, thus the jobs report across the 2 months was far less negative than nearly everyone had anticipated.

So why is such positive news proving worrisome for US investors? Why is 'not so bad' news bad for stocks and commodities (Gold fell almost $50 an ounce last Friday). Surely in a year where there has been zero to cheer about down on Main Street some little bit of respite in the labor market would be taken positively by markets, markets that are meant to represent these same economic facts and prospects? The problem of course is that financial markets do not represent economic facts, not currently in any event. There is a massive disconnect between main street and Wall Street, something that has only widened dramatically this year, despite major assurances from Messrs Bernanke and Company following the financial market collapse last year. In just six 'primarily recessionary' months Ben Bernanke and his cohorts have managed to fuel an asset bubble in stocks and commodities which in normal boom times would take 8-10 years to build. By bending over backwards and sideways, and somersaulting over the Chinese and other US debt holders, Bernanke has pumped enough ‘money for nothing’ into the system to trigger a 60% plus rally in US stocks between March and November and to infuse sufficient panic about the US ‘well being’ that investors have flooded into all forms of anti-US wellbeing financial instruments like gold, oil, every other dollar denominated commodity known to mankind and every single currency that is not a US dollar or a US dollar proxy (such as the Yuan). The resultant depletion of the value of US denominated assets relative to other currencies is quite staggering in the context of it only taking 6 months to get there. Loose fiscal policy from the US Administration and almost limitless free money from the Fed has enabled unrepentant investment banks and other greed-driven financial institutions to say thanks by creating an enormous bubble in financial markets, the likes of which has never been seen before.

The much publicized recovery we hear about every day on CNBC and Bloomberg is another one of those recoveries that is unfortunately divorced from economic reality (we love Maria Bartiroma but pretty please they need to change those other records). Hedge fund managers are falling over themselves (many on the airwaves) to try and justify their reckless trades and investments and thus the lauding of them folk Bernanke and Gross, who always seem to serve the interests of financial markets in those high gloss towers over the economic coalface down on Main Street (well, at least Bill has a colourful reason, albeit a selfish one, but our Ben was supposed to have read the black and white pictures in those 1930s annuals). If Ben or anyone looks at the latest Commitment of Traders Report on gold, we find that there is currently almost $28 billion of speculative long positions on gold (all managed funds) against only $860 million of short positions. This means a staggering 97% of speculative trades are betting that gold is going to continue to rise in value against 3% that believe it will fall – it hit $1226 an ounce last week. Such biased positions are not sustainable in the long run. They never are. Gold is very close in bias terms to where oil was in July last year before it crashed. Other notable extremes exist for many other related instruments including silver, the Aussie dollar and the Swiss franc. Trichet used to warn of such investment extremes before but even he has gone to pasture on this one, although he is the most consistent vocal on the needs for a stronger dollar, whatever that means. Tim Geithner's vocal interventions for a stronger dollar are laughable efforts and usually tend to lead to the dollar being sold off more sharply. US policy on the dollar is kinder garden stuff and when we hear officials advocate a strong dollar it usually can be translated as meaning 'a weak dollar please, but not so weak today as it might be please - (tomorrow).'

In a market where we have instruments with anything from a 2:1 to a 30:1 bias against the US dollar, it does not require sound economic reasons for market players to buy the dollar to initiate market chaos and to force a meltdown of asset prices. It simply requires a reality check on the part of those over-zealous investors (currently the majority) and to see an inevitable move on their part to the exit stalls. When a huge Stadium becomes overcrowded panic can set in more readily and a stampede could ensue, without warning. Bernanke and the world’s governing body (Central Bankers) have once again failed to patrol this particular Stadium and their general ignorance to events and their total inability to learn any lesson from what happened just 12 months ago means that the next fatal episode will lie at the door of their layer of command. They are the upper hierarchy of the global banking system, and they will be responsible for the next bubble-bust and financial crash, soon to be visited upon us, barring a miracle. Let us just hope this particular goose does not turn out to be a Bernanke roast that ends up on our table this Christmas.

We may need Bill Gross to give up the day job and work them airwaves again to keep Ben's goose at bay (mind you, it must be tough to have to manage the world's largest bond fund during a time of great economic distress, yet have all the time in the world to talk on TV). Way to go, Bill.

Bob B - Dec 7, 2009

Monday, October 19, 2009

Has the RBA lost the plot?

The Reserve Bank of Australia's decision to raise interest rates earlier this month led to a massive 8% rally in the Australian dollar against the US dollar over the past two weeks. The Australian dollar has now rallied over 50% since early March, a rally so sharp that it raises very serious questions about the currency's credibility as a reliable asset form. The currency has now seen a combined 100% swing in its valuation (50% each way) against the US dollar over the last 15 months. The Australian economy has weathered the recent recession better than all developed economies, experiencing only a temporary negative dip in GDP. How then does this explain the massive volatility in the country's currency? One thing is does demonstrate to us is that the value of the Australian dollar has very little or nothing to do with the actual performance of the Australian economy and its trade volumes, but more to do with the speculative greed driven by the 'money for nothing' monetary policy of the US Federal Reserve (and the Bank of Japan before it). The loose monetary policy of the US is seeing speculators (many of them major US investment banks) use the dollar as a funding currency to essentially sell the dollar in favour of any liquid asset that is not the US dollar. So while hundreds of thousands of American citizens find themselves being made redundant every month, hundreds of billions of the free money being given to US banks by the Fed, supposedly to stimulate the US economy, is instead being used to speculate against the US dollar and in effect bet against a credible recovery in the US, thereby triggering a rather rapid acceleration in the depletion of the wealth of the US population. The ridiculous price surges being witnessed in commodities and many currencies has absolutely zero to do with the economic principles of demand and supply and everything to do with highly leveraged risk and the unchecked and unregulated transactions of large hedge funds and investment banks.

Many Central Banks continue to misread financial markets, primarily because they have not got a clue how they are operated, let alone regulated. The Reserve Bank of Australia takes the biscuit in terms of universal ignorance and shocking misjudgment. We should not be too surprised though as the RBA is the only central bank in the developed world in recent years that intervened to try to prop up its currency at a time when it was grossly overvalued. That episode might go some way to explaining why Governor Stevens chose to hike interest rates at a time when deflation is more of a concern across the globe than inflation. The RBA have a strong Aussie dollar policy and they are prepared to risk the long-run sustainability of the Australian economy in exchange for attracting short-term funds. The US economy has suffered hugely over the past 2 years of recession and the Fed's ongoing accommodative policy of low interest rates is reflective of an economy in protracted turmoil. The most recent current account report out of the US shows the US current account deficit running at 3% of GDP over the past 12 months. The corresponding report for Australia, where the RBA has just risen interest rates, shows a deficit of 3.9%. The disconnects between the Australian dollar, interest rate policy and harsh economic reality are stark and the RBA's continual misreading of the economic world portrays Governor Stevens as a type of Alice in Wonderland type character.

Let's hope his fable does not have a sorry ending, for the citizens of Oz and all its companies that need to export to the outside world.

Bob - Oct 20

Tuesday, September 15, 2009

The Elastic Band that is the Dollar

The dollar has fallen dramatically in recent months and it took a leg lower in the past week when increased liquidity after the summer holidays saw investors put their money into higher yielding currencies and metals. Despite the usual garb being published daily about the 'dollar being finished' and US debt spiraling out of control, there are some dangerous extremes developing in financial markets again and all the evidence points to financial markets once more being divorced from economic reality. A sharp reversal is inevitable, with the strength and severity of the reversal likely to be determined by the length of time it takes for markets to meaningfully 'correct' or pull back from these extreme levels. The longer it takes, then the more taut the elastic becomes and the more severe the reversal.

Let us look at the key events that lead me to this conclusion.

1) Gold prices.
Gold has risen sharply in the past 2 weeks, to over $1,000 an ounce for the first time since early 2008. Closer examination shows that this increase is not owing to any physical demand for the commodity but by speculative demand from money managers. Open interest hedge fund positions in gold at present, sees over 98% of hedge fund monies being net long on gold. This is an extraordinary extreme no matter how one looks at it and history tells us biased positions do not last forever and the greater the bias the greater the potential for a fall or collapse. Astute money managers should right now be reducing their exposure to gold for this reason, if for nothing else. Gold has the potential to retreat back to $800 or even less within no time, if some event triggers a sale. Central banks could deliberately bring about this collapse in the gold price, if they chose to do so, and there are several reasons why it might be in their economic interests to do so. Gold is traditionally used as a hedge against inflation but currently the globe has a deflationary problem and present and future US market rates do not hint at any looming inflationary issue for the world's largest economy. Gold prices are completely out of sync with interest rate expectations, which indicates gold prices are greatly inflated at current levels. Be warned!

2) Commodity Currencies.
The economic exaggeration currently reflected in equity prices is also evident in the price of commodity currencies. The Australian and New Zealand dollars are up over 40% against their US counterpart since March. The Canadian dollar is up over 20%. The global recovery story is only in its infancy and currency moves of the order of 40% are nonsensical, particularly for the Aussie and New Zealand dollars which represent economies with pretty dire current account deficits. This currency appreciation is based entirely on market speculation. 90% of non-commercial open interest in the Aussie dollar on September 1st was made up of speculative long positions. This represents an unsustainable extreme. It also demonstrates that Central banks have yet to grasp how speculative financial markets are free to derail competitive currency exchange. Central Banks have learned nothing from the recent market collapse and they continue to watch in silence as leveraged speculation in currencies leadings to a pronounced instability in exchange rate markets. The Australian and New Zealand dollars are due for sizeable corrections sooner or later, with both currencies currently punching well above their real exchange rate values.

3) Japanese Yen
What has been striking about the past 2 months in particular has been the replacement of the Japanese yen as the world's favourite funding currency (i.e. by speculative risk merchants) by the US dollar. What this means is that carry trades (speculative bets on higher yielding currencies) are now carried out using the US dollar (the dollar has a paltry 0-0.25% yield rate). 3 month libor rates currently have the dollar cheaper than the yen as a funding currency for the first time in many years. Carry trades, while attractive in some ways, are also very destructive to international trade competition as a large volume of speculative bets involving the same funding currency has the effect of depreciating the value of that funding currency, sometimes quite considerably. We also know that market scares lead to unwinding events that can result in a very sharp appreciation in the funding currency. We have seen this over many years with the yen and for now the dollar is the favoured vehicle for carry trades. At present almost 80% of open interest in the Japanese yen is net long, a quite remarkable position given we have had almost 6 months of unbroken growth in stock markets and sustained investment in riskier assets. It is safe to assume that the the bulk of the biased positioning in the yen right now is against the US dollar and any eventual return to impartial positioning, will result in a sharp reversal and a significant rise in USD/JPY. It is almost certain that interest rates will rise in the US before Japan and will rise much more quickly, something that will spark major capital flows from yen to dollars. The market will figure this one out eventuality, sooner rather than later, so look out for a sharp rise in USD/JPY before the end of this year.

What most speculative traders and daily analysts tend to ignore is purchasing power parity. It is almost incredulous that over a period of a few months an Australian can buy 40% more with their money than a US citizen can in US dollar terms. The prior Aussie rally to over 95 US cents can be discounted as that was driven exclusively by an asset bubble that burst last year. The differential standard of living in both the Australian and US jurisdictions has hardly changed in the past 6 months, yet the exchange rate markets that Central Banks have criminally refused to regulate now sees Australian citizens being able to buy 40% more than US citizens thanks to the unchecked greed of hedge fund managers. Of course we know that this is a false exchange rate, but at the same time it presents a fantastic opportunity for Australians to buy up US dollar denominated assets at a huge discount. Much the same can be said for Japanese and European (non-UK) investors. Because of the weak dollar exchange rate, it is an excellent time for Asian Banks to buy US Treasurys. European bonds are grossly over-priced for the Japanese and Chinese because of an inflated euro (which is over 20-25% overvalued) and the safer option in the longer run is to stick to buying US bills (forget what the doomsday merchants claim for the US, because we have learned in the past 2 years that the US is where it matters and that any negative contagion from there is global). Capital flows will eventually flow back into the US because of the gross imbalance in PPP and it will happen in a very significant way, once evidence of sustained economic recovery in the US is firmly established. The euro is currently benefiting in an environment that sees zero to minimal capital investment in the non-speculative 'real' economy,' but it will find itself out of favour when capital flows begin to pick up in earnest, quite simply because it is way too expensive to invest in the Eurozone. Even in good times, Eurozone economic growth is always a laggard behind the US and Asia.

Bob B - Sep 15, 2009