The Falling U.S. Dollar: Taking An About-Face

December 26th, 2008

The Falling U.S. Dollar: Taking An About-Face

by Louis Basenese, Advisory Panelist, Investment U
Associate Investment Director, The Oxford Club
Wednesday, December 17, 2008: Issue #902

Investing requires tough decisions. What to buy? When to buy? How much?

But none more difficult than this: Admitting the fundamentals no longer support an investment you own. Or, as the French philosopher Geoffrey F. Abert summed it up over 900 years ago, “It often takes more courage to change one’s opinion than to stick to it.”

And today I’m living proof.

Just three weeks ago, to the day, I declared, “The dollar’s not done.” I laid out my case about Jim Roger’s being wrong.

But I’m officially changing my stance on the falling U.S. dollar.

To be clear, it’s not because I finally saw the light, recognized the error of my ways, or heeded the “sage” advice of so many of you that wrote in to chastise my “foolishness” or “ignorance.” And I didn’t get a personal phone call from Jim Rogers, either.

I don’t cave to bullying or criticism. Just fundamentals. And the bottom line is this – for most of the year, the fundamentals supported a stronger dollar. Enough so to allow my subscribers to lock in gains shorting the euro versus the dollar of 12%, 58%, 60%, even 267%.

But those fundamentals changed. Big time. So here’s what you need to know, and how this fundamental change could be as profitable as the last one.

U.S. Dollar Doubts Surface As Investors Give Up On Yield & Value

My first doubts about the U.S. dollar surfaced when investors gave up on yield and value. In return for, well, no return. Remember, last week I reported demand for four-week Treasury bills – offering ZERO percent interest – outstripped supply four times over.

If that wasn’t bad enough, I noticed investors on the long-end of the bond market weren’t investing any smarter. All they want is “safety-only,” too. Case in point – the yield on 10-year and 30-year Treasuries fell below 3%.

Forget below average. Such paltry yields represent the lowest levels in the last 50 years.

So what’s the big deal? Well, it’s the equivalent of Bank of America putting out a curbside sign during the real estate run-up advertising “no-documentation1% mortgages.” People can’t resist cheap money. And we shouldn’t expect our elected representatives to show any better restraint. They will borrow cheaply and spend freely, while they can.

And it’s the extent of this spending that troubles me, and threatens the dollar the most.

The Flood is Coming and There’s No Ark to Save The Dollar

Forget the $530 billion of government debt that flooded the market last quarter. Or the $550 billion estimated for this quarter. President-elect Obama is planning a tsunami.

If you have any doubt, just consider the trend in estimates for his soon to be released economic stimulus package.

A few weeks ago, $500 billion was the consensus number.
Then it crept up to $700 billion.
Now, Republicans and Democrats alike believe the final plan will top $1 trillion.
And that’s on top of the $4 trillion price tag for his proposed middle-class tax cut and universal health care.

The only way to absorb the impending and massive Treasury issuances will be for the Fed to flood the market with dollars. Or put more plainly, to run the printing presses 24/7 – which many of you already suspect they’re doing.

Arguably, these factors alone should be enough. But I’m stubborn. I wanted one more thing before I let go of my dollar bullishness. And yesterday I got it.

The U.S. Dollar Index Breaks An Uptrend

Recall, in July the U.S. dollar index bottomed out and entered a confirmed uptrend. But after rattling off about a 20% gain, everything just came unglued. And yesterday, the U.S. dollar index officially broke through the uptrend line. So look out below. Because there’s no telling where the next support level rests.

That being said, I don’t think it’s time to do the opposite of my previous recommendation, and get long the euro. Not hardly. The recent hawkish comments out of the European Central Bank scare me. They won’t be able to escape this financial crisis either, no matter how defiant the rhetoric. Plus, euro-zone banks still need to unwind as much as $800 billion of dollar-denominated leverage.

In short, the upside in the euro versus the dollar will be subdued. Not to mention, a far better opportunity exists shorting long-dated Treasuries.

As The Bond Market See-Saws…

The bond market is remarkably simple – it’s a seesaw, with interest rates on one end & bond prices on the other. When one goes up, the other goes down.

If you have any doubt, consider recent history. As the Fed aggressively cut interest rates, bond prices went vertical. Up 20% in some cases. That’s unheard of for bonds. And it represents our newest bubble (first real estate, then oil, now treasuries).

Make no mistake, this bubble will end just the same.

First, because the government can’t get away with near zero yields forever. Investors will eventually demand a respectable return on their money. Especially foreign governments. In the last quarter alone they increased their U.S. debt holdings by 12%, according to Bloomberg. To load up even more will require additional compensation.
Second, because inflation is around the corner. Never has a world government spent (or planned to spend) so much and avoided it. The only way to curb the resulting inflation will be for the Fed to abruptly reverse course, and begin raising rates at the first signs of an economic recovery.
Bottom line, the only way for rates to go from here is up, which means bond prices will head the opposite direction.

Again, I aim to be transparent in my analysis. Always. And that includes defying Lillian Hellman’s observation that “people change and forget to tell each other.”

Consider this your notice. My outlook for the falling U.S. dollar has changed, albeit quickly.

This isn’t an apology. It’s simply a head’s up that more compelling opportunities exist. One a fellow colleague summed up perfectly, “If you don’t short Treasuries right now, you’re dumber than investors buying them for a zero percent return.”

A bit harsh. But hard to refute.

Good investing,

Lou Basenese

Editor’s Note: So far this year, Lou’s White Cap Index is up 135%. He just released the next 5 companies about to be added to it. And one of them is already up 87% over the last 47 days. To get exposure to the soaring White Cap Index today, here’s The White Cap Report.

Today’s Investment U Crib Sheet

Yesterday’s interest rate cut sent the markets up almost 5%. But as investors digest the impact of lower rates, the market has dropped almost 1%. As Lou mentioned, bondholders could see the price of their bonds start to sink, and Treasuries are a losing proposition.

But there are a few locations to put your cash if you’re looking for safety. In fact, all of them look better than a zero percent return.

Currently, here are the average short-term rates for cash like investments:

One-Year CD 3.10%
Money Market Accounts 2.32%
Interest Checking 1.26%

Money market funds are appropriate for the cash portion of a diversified portfolio, individuals needing the funds in a one to six month timeline, or those who require immediate liquidity. And there is some good news for investors in “cash” investments.

The inflation rate dropped again in November to 1.07%. Recall in July that it was 5.6%, erasing the gains of many short-term investments, regardless of where they were.

Lou Basenese has given us a number of compelling opportunities recently. But if you’re looking for his most recent picks, take a look at the White Cap Index. It’s up 135%, on average, over the past 12 months. To get the full report, including five companies Lou ’s about to add, learn more about the White Cap Report.

Related Articles:

Jim Rogers is Wrong… The Dollar’s Not Done
The End of The Weak Dollar: Top 10 Reasons the Greenback’s Finally Headed Higher
A Weak US Dollar: The Decline of the Dollar but Why A Crash Is Unlikely

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