Wednesday, September 8, 2010

Hedging Against U. S. Dollar Weakness Caused by Federal Reserve Policy

The major theme I am focusing on these days is prospective U. S. dollar weakness and how to invest accordingly as a U. S.-based individual.

You may click on the enclosed charts to enlarge them.

This is Part I, with one or more additional parts to follow.

I think that most investors based in the U. S. continue to have the vast proportion of their assets tied to the dollar, or naturally so if the holding is real estate based in the U. S. Our dollar has been the reserve currency of the world for everyone's investment lifetime . . . but it's been having its ups and downs. Here are some reasons why I have been allocating an increasingly large proportion of my financial assets in non-dollar and anti-dollar vehicles, and commentaries of which vehicles I have chosen.

The case that the U. S. dollar is fundamentally overvalued is well made by John Hussman in a post from a few weeks ago titled Why Quantitative Easing is Likely to Trigger a Collapse of the U.S. Dollar.

Please read the discussion as he presents it. My thumbnail summary is that by suppressing the rates on Treasuries below market via its various debt purchases (creating "inflation" in the Austrian sense of the term), the Fed is inducing markets to rapidly and substantially decide to devalue the exchange rate of the U. S. dollar (the "dollar" herein, as opposed to dollars of other countries such as New Zealand). I agree and want to hedge against a de facto dollar devaluation. This multi-part series begins with a mention of gold and then introduces other assets I have been accumulating for at least six months.

The purest way to hedge against the dollar's decline is by owning currencies against which said decline will occur, as opposed to indirectly doing so by owning stocks of companies doing business in foreign countries.

It appears to me that this trend predicted by Dr. Hussman is playing out quietly under cover of a euro that is at this time even weaker than the dollar. I am not involved in investments that have a short-term focus, however. This is more of an intermediate (months to years) strategy in my mind.

Once again, the commentary provided is mine alone, the opinions are mine, and nothing represents investment advice.

At this juncture in the markets, the ultimate "currency" continues to be gold. Gold has just set what has to be the quietest all-time closing high for a major asset class in memory. I was lucky enough to successfully trade an important intermediate top in gold and described said tactical trades in a post on December 3, 2009. The major reasons for severely lightening up then were that exchange traded gold funds such as Gold-Trust (GTU) had gone to significant premia over net asset value, the pricing appeared extended, and there was lots of excitement about gold on such websites as Zero Hedge.

Now, GTU and the more newly-launched "PHYS" gold ETF are at relatively low premia to NAV and for some time now, there has been little excited talk about gold on Zero Hedge. Compared to December 3, 2009, the metal is much closer to its 200 day moving average and is up year-on-year much less. So I am not inclined to sell any gold. If the comparator investment is a 5-year Treasury yielding almost certainly less than consumer prices will increase, how likely is it that at some point within the next 5 years, gold's price will allow gold-related investments to be sold at a profit that exceeds the return from that 5-year note? I think the probability is very high.

This series of articles is not going to discuss different ways to invest in gold. That will be addressed in the future.

In addition to gold vehicles, I have identified one other commodity in which I have invested, and three other currencies. The commodity is silver, and the currencies are those of Norway, New Zealand and Brazil. The other chart shown above is an exchange-traded fund that provides the return equal to money market rates available in Brazil (very roughly 10%) minus fund expenses, with full currency risk vs. the dollar. Not shown is a similar ETF for the New Zealand dollar, "BNZ".

In contrast, the only way I know to invest from America in the Norwegian kroner is by purchasing Norwegian sovereign bonds through a full-service broker.

Norway is in good part an oil-backed country, so I view its kroner as a form of a commodity currency; New Zealand has a large commodity role given how many sheep and cattle it contains per (human) capita; and Brazil is a special case with a strong chart pattern for BZF.

In Part II, I will discuss silver on its own merits and in relation to gold. Discussion of the above-mentioned countries and their currencies will follow.

Copyright (C) Long Lake LLC 2010

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