Stagflation Update: Focus on the U. S. and Brazil

On February 28 of this year, I wrote a post for The Daily Capitalist titled "Getting Real". Its focus was the bullish case for the Brazilian real. Since that time, the real has appreciated about 1% a week. The closed-end fund that tracks the value of the real vs. the U. S. dollar, stock symbol BZF, was $26.88 then and may open around $28.40 today. The real is near its 2008 high against the USD.

Yet the case for the real may still be quite strong, at least against the USD. Interest rates in the U. S. are collapsing on the short end. They are a negligible 0.03% and 0.11% annualized for 3- and 6-month T-bills respectively as I write this at 8 AM Eastern Daylight Time. Meanwhile, the monthly price inflation rate in the U. S. as measured by MIT's Billion Prices Project is running around 0.48% monthly. Compounded over one year, this is well over 6% yearly. So the U. S. is running hugely negative interest rates. Brazil, on the other hand, has a flattish yield curve and interest rates in the low double digits while price inflation is running around 6%. Thus their interest rate structure is strongly positive. Brazil received a credit upgrade from Fitch this week to BBB. Brazil is also not a net importer of oil and is expected to be a net exporter later this decade, so the current oil price trends should be real-friendly on the margin.

On the budgetary side, the pro-life and pro-choice wings of the Republicrat/Demopublican party (AKA the Establishment) take turns posturing that they are fiscally responsible, except when they seize complete control of the government, at which point they always find some emergency requiring massive deficits and credit expansion. Part of the emergency spending always involves the military. The view from foreign shores is of a floundering country that purports to be the world's leader. Yet it can't even pass a budget, more than halfway through a fiscal year. None of this is dollar-friendly.

In contrast, the new leader of Brazil, Dilma Rousseff, recently addressed her country's budget deficit by doing such measures as canceling a major order for fighter jets that Brazil had been looking into for quite some time. Good for Dilma. Brazil has no natural enemies. They should spend on education, not the military, so they can move up the economic food chain.

So, strictly on interest rate differentials, it's hard to see a reason for the real to drop against the USD. If the real stays unchanged vs. the USD, ownership of BZF should yield at least a 10% return in USD terms over one year. That's a powerful lure in favor of the real.

In the broader sense, the ultra-low velocity of money that current U. S. T-bill rates imply does not bode well for the short-term future of the U. S. economy, in my opinion. These rates also suggest that a lot of capital would (to be anthropomorphic) rather receive essentially no interest payment than take the risk of today's stock and bond prices. Whether commodities, which are on a roll again, are included in that calculation is unclear.

With the average of Brent crude and West Texas Intermediate around $118/barrel this morning, oil importing countries are facing significant headwinds. Thus, the message of the markets I see for the U. S. involves a sea of troubles. So much funny money has been electronically printed in the past few years that it's hard to say what oil price is the tipping point for the American economy, but given how little wage increases have occurred, I'm nervous right about now.

Fed policy may be back to that of the 1940s, controlling short rates to an extreme level below that of price increases, but geopolitically, it looks more like the stagflationary 1970s to me, with the U. S. dollar having nowhere to go but down. Thus economic constraints can suddenly appear, leading the economy to slow and financial markets to turn on a dime.

Caution is especially prudent at times such as this. As is, in my opinion, continued exposure to precious metals vehicles and oil stocks.

Copyright (C) Long Lake LLC 2011

That Was Quite the Week That Was, but the Depression Continues Nonetheless

Lifted on a sea of purportedly easy money and visions of the neutering via secret ballot next month of the president 55% of likely voters surveyed by the Ragin' Cajun, James Carville in a midyear poll believed to be a socialist, it was "risk on" this week. The assets repeatedly highlighted here, from gold/silver/Brazilian real to AAPL were strong, but there's a big But.

There is a disturbing pattern. The financials are lagging. This is the dark side of the current ebullient market, which is both so different from that of 2006-7 but so similar. As in 2006-8 (first part of 2008), gold/silver/oil are surging; junk bonds have been surging for some time; yet as in 2007, the people think the economy is in a recession. The people were right, more or less, in that while the economy was allegedly booming in fall 2007 just as the stock averages were hitting all-time highs, Americans were about evenly split about whether the economy was already in recession. The people got it right. I know. I was one of those people who did not trust the economists. It was clear to me in summer 2007 that housing was in a depression, autos were in a severe recession (GM and Ford already were rumored to be in danger of failing), and therefore the domestic economy was already in deep trouble. Hey-that's about half of the domestic economy right there, counting all their related industries.

Now, Gallup shows that, on a 14-day average, self-reported discretionary spending was only $59/day, which is down by about 50% from peak levels.

Not. A. Real. Recovery.

Meanwhile, assuming there is a semi-free market for money, the collapse in the 2-year note to about 0.35% yearly and the collapse in the 5-year note to little over 1% yearly is not consistent with a stock market surge. It is, however, consistent with a domestic depression.

But not the Great Depression, either. Think Japan as the current template.

(Better Japan than Greece, that's for sure!)

How then can be that McDonald's, gold/silver/oil, IBM, etc. can surge, several of them to or near all-time highs, while the National Federation of Independent Business and numerous other surveys show a chronically weak economy and federal and state tax receipts disappoint?

Is it lunacy?

Not necessarily.

It's the rest of the world; as Mr. Carville might have added in 1992: ", stupid".

Do Messrs. Obama and Bernanke feel just a bit abashed, even humiliated, that Brazil and Peru have been buying U. S. dollars to stem the ascent of their currencies against that of the colossus of el Norte?

Or that the most recent estimate of India's economic growth rate was raised to 9% while our current and projected growth rates were lowered to low single digits?

Just wait till you start hearing of how badly our workers are treated when they go south of the border for work.

There are, however, some domestic investment opportunities in the U. S., to be discussed in the next couple of days.

Copyright (C) Long Lake LLC 2010

Hedging Against (Further) U. S. Dollar Weakness: Part III

On September 8, I put up a post about ways to hedge against or profit from a decline in the U. S. dollar (the "dollar" herein, as opposed to dollars of other countries, also the "USD"). I listed three asset classes: gold, silver and certain foreign currencies. That post focused on gold and was followed up by a post on silver. This post discusses currency-related tactics I have been employing in personal investing.

An important impetus for the dollar weakness is that the Recovery Summer that the administration touted a few months ago has turned out to be unfelicitously named. The pace of economic growth has turned down, and even the Economic Cycle Research Institute has stated that there was a roughly 50-50 chance of another recession (the famed and so far unidentified "double dip") beginning soon.

This economic weakness has been associated with two dollar-weakening activities from the Fed. One involves the newly-introduced program in which the Fed has begun purchasing Treasury debt from the primary dealers that purchase the debt. This has been viewed in many circles as "monetizing the debt", a technique previously limited, in American eyes, to lesser countries.

A second involves the discussion by the Fed of the potential advent as soon as next month of another 2009-style "quantitative easing" program known colloquially as "QE2"; click HERE for a thorough though characteristically downbeat Zero Hedge discussion of this possibility. The mere discussion of this possibility (probability?) has already contributed to weakening the dollar.

A more fundamental reason to diversify from the dollar comes from the General Accounting Office of the United States, which reported on its latest audit of the federal government:

Three major impediments continued to prevent GAO from rendering an opinion on the federal government's consolidated financial statements . . .: (1) serious financial management problems at the Department of Defense, (2) federal entities' inability to adequately account for and reconcile intragovernmental activity and balances, and (3) an ineffective process for preparing the consolidated financial statements.

When a company's auditor cannot render an opinion on that company's financial statements, one has to worry about fraud and possible bankruptcy. So, exactly why is Federal debt trading at about 240 times "earnings" for a 2-year commitment of capital? Why not diversify into a higher-yielding vehicle from a country that has stronger audited results?

Since that September 8 post, the dollar has weakened a good deal for a short time period. A Bloomberg article summing up the trading week ending October 1 summarizes:

The Dollar Index, which IntercontinentalExchange Inc. uses to track the greenback against six major counterparts, extended its biggest monthly drop since June 2009. The Dollar Index declined 5.4 percent in September, the biggest monthly decline since May 2009 when it fell 6.2 percent.

Nonetheless, the dollar is far from historic lows, and investors who wish to have non-dollar exposure on a time horizon extending beyond considerations of possible short-term "overbought" conditions may want to consider any of these positions, which I continue to hold as of the October 2.

My direct foreign-currency denominated exposure is to three countries: Norway, New Zealand and Brazil. Here is my reasoning and some detail on how to invest in each country's debt or currency.

I did research in non-mainstream U. S. raters of governments and found that while the U. S. federal government is not apparently near bankruptcy, it is also not a true AAA credit. In contrast, both Norway and the "twins" of Australia and New Zealand have garnered "true" AAA ratings both by a prominent Chinese rating agency and by some hard money authorities. Here is the Chinese agency's list of AAA-rated sovereigns:

Dagong rates Norway, Denmark, Switzerland, and Singapore at AAA, along with the commodity twins Australia and New Zealand.

Here is Eric Sprott's list (Mr. Sprott runs hard money investment vehicles):

. . . our model ascribed AAA ratings to the local currency debt of Australia, Canada, Finland, Sweden, New Zealand which matched the ratings given by S&P . . .

(Click HERE for a link to S&P's country rating list.)

Before going into the following details, interested readers may wish to look at charts of various currencies against the U. S. dollar. I routinely do this by going to http://www.finance.yahoo.com/ and then putting in the currency pair symbols where a stock symbol would go. For the three currencies I mentioned previously and discuss below, the way to look at these so that they are oriented that a rising foreign currency against the USD shows a rising chart (bottom left to top right, as with AAPL or NFLX) is to type in the currency symbol followed by USD. Thus to see how the Norwegian kroner has fared against the dollar, the symbol is NOKUSD. For the New Zealand dollar against the USD, the symbol is NZDUSD. And for the Brazilian real, the symbol is BRLUSD.

There are of course innumerable forex trading and other sites that provide the information that the Yahoo! sites do. I like Yahoo! because it provides multi-year charts, which most free forex trading sites do not show.

Norway

The kroner is a form of petrocurrency, so that provides a hard (liquid) asset behind it. The country has a sovereign wealth fund that has about $100,000 equivalent of financial assets for each citizen. Debt levels are low. Its currency, the kroner, is more attractive to me than that of Sweden, which uses the euro.

Unfortunately for investors, the only ways I know of to invest in Norway's currency are through its bonds and through foreign exchange futures trading, and I don't do the latter. So I have purchased Norwegian bonds, which yield more than U. S. bonds, especially on the shorter end of the curve. Thus I have a yield that is a little more than a U. S. government yields denominated in what I suspect is a somewhat higher-quality bond; and in a currency pair (not shown) that has been relatively stable over many years, with an oil and gas kicker on my side. If the dollar weakens, I get the stated yield plus currency appreciation. If the dollar strengthens, I get the yield minus the kroner's depreciation, but because that might correlate with lower oil prices or, simply, a stronger U. S. economy, I might be happy with the overall situation. That to me is the essence of hedging.

New Zealand

I have nothing against Australia, but I chose the currency of its "twin", New Zealand, instead, due primarily to a housing bubble in "Oz" that may dwarf that of the U. S. (Of course, the countries are quite different and are at their closest point more than 1000 miles apart.)

New Zealand is similar to Norway in population. Both have somewhat over 4 million people. New Zealand continues to have a large agricultural export sector, and I speculate that Asia will continue to expand its real income and thus will place upward pressure on prices for New Zealand animal- and vegetable-based exports.

New Zealand has higher interest rates than Norway and for reasons that are unclear to me, there is enough interest in its currency that an exchange-traded fund with the symbol BNZ exists on the NYSE. Purchase of BNZ exposes an investor to money market-based income available in New Zealand as well as to the fluctuations in the exchange rate between the U. S. dollar and the New Zealand dollar. I own BNZ as well as sovereign debt of New Zealand denominated in New Zealand dollars.

I do not read Norwegian, but I am able to read New Zealand's official documents. Unlike the U. S., the government of N. Z. has an unqualified thumbs up from its auditors. From half a world away, it appears to me as though, similar to the Norwegian government, the N. Z. government is realistic about its finances and has been willing to impose taxes to support its expenditures.

A caution on the BNZ fund. It is not very liquid. Thus it is unsuitable for short-term trading.

Brazil


Finally, the risk-taking side of my investment nature scoured the globe for suitable high yields. So I settled on Brazil, about which the longstanding joke has been that is has always had a bright future, and always will have one. Well, after a long road back from one of the world's longest-ever bouts with hyperinflation, Brazil now has a low-investment grade rating from three agencies:

Brazil’s credit rating outlook was boosted to positive from stable by Fitch Ratings, which cited the country’s “growth dynamics” and “prudent” policies. Fitch rates Brazil BBB-, the lowest investment-grade rating and in line with rankings from Standard & Poor’s and Moody’s Investors Service.

There is more positive news about Brazil's federal finances. From the IMF's Public Financial Management Blog (click HERE for a link to the general blog site and the headline below for the specific report on Brazil):

With 17 “gold medals” Brazil beats Norway on the PEFA assessment

Gold medals are the objective reference for success in the world of sports. In PFM, you may measure success by the number of “A”s scored on the PEFA assessment. A recent World Bank PEFA report gives Brazil the lead with 17 A's! Even better than solid, dependable Norway! Is the PEFA representation accurate? Is Brazil world leader on PFM, or is reality a bit more complex?

Brazil has been reforming its public financial management systems since the 1980s. The implementation of the fiscal responsibility law (FRL) in 2000 can be considered the major landmark that put the country in the forefront of PFM good practices. The FRL improved substantially the coverage of the budget and fiscal reports, imposed macrofiscal safeguards on debt management and public expenditure, provided for the preparation of a fiscal risk analysis to support the budget process, and pushed for timely and reliable fiscal reports. The impact of the FRL is clearly perceptible in three of the six pillars of the PEFA assessment (credibility of the budget; comprehensiveness and transparency; and accounting; recording; and reporting). From 14 indicators in theses three dimensions Brazil scored “A” in 11.


So this may be a different Brazil from the country that suffered hyperinflation - maybe that was "so last century" . . .

Brazil reports consumer price inflation of about 5% per annum and short-term interest rates more than double that. Thus, similar to that which was in effect required of the U. S. by international lenders after the very weak dollar period in the late 1970s (following prior dollar crises in the 1960s and early 1970s), Brazil may be rewarding investors rather than borrowers by (per official statistics) providing a high "real" rate of return.

Above is a stock chart of an ETF similar to that available for the New Zealand dollar, this one for investment in Brazil's currency, the "real". This ETF has the symbol BZF. It is fairly liquid. The chart shows that this has been a strong performer lately. It may have moved "too much" lately, but that can only be known in retrospect. The Brazilian real remains a little below the highest value it has reached vs. the U. S. dollar in 2008.

It is not easy to directly purchase Brazilian bonds from America. It is possible to purchase transnationally-guaranteed bonds denominated in reals, with a lower yield than Brazilians get, though with principal guaranteed by the transnational organization.

Unlike the "advanced" countries, Brazil has much younger demographics, neither engaged in epidemic mortgage fraud nor reached for yield by buying complex mortgage-related securities emanating from the U. S., and had no banking crisis the last few years. Brazil has a generous helping of natural resources and is not an importer of oil.

Not wasting money on foreign wars or on dead-end expenditures on armaments is good for an economy and therefore a currency's value. Norway, New Zealand and Brazil all are at peace and have no apparent prospect of needing to ramp up their military spending. They have very different economies from each other.

Anyone interested in BNZ or BZF may find detailed information on them at the website of their sponsor, http://www.wisdomtree.com/. (I have found calling WisdomTree to get a better understanding of these products pleasant and informative.)

Purchase of international bonds naturally requires more advanced brokerage services than purchasing an ETF.

Nothing written here constitutes investment advice to anyone.

Copyright (C) Long Lake LLC 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

Too Many Loud Voices of Support for the Dollar for Comfort

Skeptical minds are questioning the implications inherent in the Bloomberg.com article, Russia’s Kudrin Signals No Alternative to Dollar Global Status. Please consider all the following from the article:

Russian Finance Minister Alexei Kudrin said the dollar is in “good shape,” further affirming that there’s no substitute for the world’s reserve currency.
Kudrin rushed to reassure investors of Russia’s confidence in the dollar just days after his boss, President Dmitry Medvedev, questioned its global status, joining China’s central bank Governor Zhou Xiaochuan in suggesting the world may need another benchmark for settling international debts.
“It’s too early to speak of an alternative,” Kudrin said in an interview two days ago in Lecce, Italy after meeting officials from the Group of Eight nations. . .

“At this point there’s no alternative to the U.S. dollar in terms of deep liquid markets and trading 24-7 globally,” Michael Woolfolk, senior currency strategist at the Bank of New York Mellon in New York, said yesterday in a telephone interview. “Nothing even comes close to the dollar in terms of reserve status.” . . .

The dollar got some support last week when Japanese Finance Minister Kaoru Yosano said his country’s confidence in U.S. Treasury securities is “unshakeable,” signaling the second- biggest foreign holder of the securities will keep buying them.
“We have complete trust in the fact that the U.S. views its strong-dollar policy as fundamental,” Yosano, 70, said in an interview in Tokyo on June 10 before attending the G-8 meeting of finance ministers in Italy. “So our trust in U.S. Treasuries is absolutely unshakable.”

Over the past two years, it has become clear that the United States has committed a fraud upon the rest of the world by creating securities tied to loans on the value of housing in the U. S. These loans, called mortgages, were "packaged" in inscrutable ways and are defaulting at ridiculous levels despite allegedly high-class U. S. rating agencies having blessed these securities as "AAA". Other AAA and less highly-rated U. S. loans have proven unsound, as well.

Furthermore, the Bushbama Continuity has perpetuated the malinvestment here in homes, rather than directing investment to export-oriented industries in which the U. S. actually has a competitive advantage.
These industries include medical technology, information technology, agricultural know-how, and even- somewhat oddly- financial services knowhow.

The more the U. S. continues to bail out homeowners and especially the holders of the mortgages, the weaker the dollar will trend.

All the above expressions of support for the dollar only serve to demonstrate its weakness. It's obvious who Charles Atlas is when lined up against the 97-pound weakling. Right now, the U. S. is Charles Atlas in the advancing stages of a wasting disease, and the former weaklings are continuing to bulk up.

The only safe way to make money from a continuation of this trend is to own the once and possible future currency known as gold, though only with a very long-term horizon. Owning BZF (the Brazilian real) on pullbacks continues to make sense.


Copyright (C) Long Lake LLC 2009