Gold and Bonds

It's hard to see the fundamental case for gold vs. the U. S. dollar (USD) as other than strong when a flawed currency, the New Zealand dollar (NZD), has just now broken to an all-time high against the USD. Why is the NZD a flawed currency?

Because the policy interest rate is 2.5% while the latest inflation rate is 4.5%. The Prime Minister of NZ is a former Merrill Lynch banker. These guys do like printing money, that's clear. So if a country that is rebuilding after the Christchurch earthquake is doing it with cheap money, then gold should be appreciating against the NZD, all things being equal. (Please note that the NZD was one of the three currencies I highlighted last summer when I made the case for the following weak dollar plays: gold, silver, and foreign currencies. The other two courrencies I listed were those of Brazil and Norway.)

Except for countries near default, such as Greece, and with some exceptions such as Brazil and Chile, most of the world continues to operate with negative real interest rates. Sweden, for example, has a 3.3% inflation rate but only a 1.75% policy rate. All this is gold-bullish. Just last week, gold hit all-time highs in euro and British pound terms.

Is gold "too high"? Maybe, but given how depressed gold miners are, my sense is that a bull market as long and strong as gold's has been will generally end with public participation in the usual manner, namely in stocks. Instead of gold, the public has been indulging its dreams of easy money via momentum stocks of various flavors. I continue to look for $2000/ounce gold next year based on the "Elfenbein correlation" between percentage appreciation of gold and the positivity or negativity of "real" short term interest rates.

Understanding that there is a significant potential for summer weakness in all resource stocks, I also think that on a 6-12 month horizon, certain gold stock vehicles look better than bullion to me.

The big fly in the ointment, however, is the Economic Cycle Research Institute's adamant call for an important top in the global industrial economy soon. Primarily because of this, I am avoiding resource stocks except those related to gold (which has few industrial uses) and resource currencies.

As a consequence of a global industrial recession, at some point I would see capital being diverted to bonds. In that vein, I would note that the long-term downtrend line in U. S. interest rates survived the inflation scare of this winter. The chart of the same bond in New Zealand is similar at least for the past decade. (Click on chart to enlarge.)

On a trading basis, I am therefore long various U. S. Treasury debt instruments. I thus have a barbell strategy: gold as my core holding to hedge against more money-printing to make the impaired balance sheets of the TBTFs whole, and Treasuries as speculative vehicles expecting that potentially sharp downtrends in the prices of industrial commodities in association with a global industrial recession (or fears thereof) will leave capital searching for the least bad alternatives.

I also own some defensive stocks and certain specialty financials.

I intend to discuss some ins and outs of Treasury investing (speculating, really, given that I don't expect the debts to ever be repaid in other than greatly devalued dollars) in the future. In the meantime, you may wish to review a November 2010 post on the topic in which I suggested that we could then have been within months of a major top in long term rates if we were not there already (which we most assuredly were not, as it turned out).

I read lots of gold-oriented blog sites, articles on gold, etc. I don't know if I am unique, but I think it's rare to be a bull on gold and a tactical bull on intermediate to long-term Treasuries at the same time. Let's see how the months ahead go. It looks interesting, to say the least.

Copyright (C) Long Lake LLC 2011

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