Is US dollar headed for doldrums?
William R. Thomson
15 June 2006
Roundtable Business Times Singapore
©2006 Singapore Press Holdings Limited
OVERVIEW
MARKETS have sounded the retreat. This week
the Dow Jones Industrial Average felle below 11,000 for the first
time in three months and other markets have fallen sharply in
sympathy. As one of our panelists in this week's Investment Roundtable
notes: 'With so much leverage in the markets, the potential for
ugly corrections over the summer is high.'
The situation at present, he suggests, resembles in many ways
that of the summer of 1987 before the last market crash. That
proved to be a baptism of fire for Alan Greenspan, the immediate
predecessor of Federal Reserve chairman Ben Bernanke. Could Mr
Bernanke be in for a similar welcome now? Other problems that
could come to the fore are those with derivatives and the unwinding
of the yen carry trade.
Where to look for shelter from the coming storm? If there is
one thing on which our panellists are in total agreement, it
is that the US dollar offers no haven; quite the opposite. But
they do favour some exposure to the Singapore dollar, and a diversified
portfolio of investments that should enable readers to ride out
the storm.
PARTICIPANTS in the roundtable:
Moderator: Anthony
Rowley, BT's Tokyo
Correspondent.
Panelists:
Marc Faber, Investment adviser and publisher of the Gloom,
Boom and Doom Report.
Christopher Wood, Managing Director and Equity Strategist,
CLSA Asia-Pacific Markets.
William Thomson, Chairman of Private Capital Ltd., an
advisory company in Hong Kong. He is also a senior adviser to
Franklin Templeton in Hong Kong and Axiom Alternative Funds in
London.
Anthony: Welcome gentlemen,
and thank you for taking time out from your busy schedules at
this time of extreme turbulence in financial markets. Investors
are running scared of inflation and the assumption is that most
markets are going to continue experiencing turbulence as political
tensions in the Middle East continue and the dollar remains volatile.
Likewise, the outlook for interest rates and currencies is giving
rise to angst, speculative positions in commodities are being
unwound and derivative positions are getting squeezed by the
contraction in global liquidity. Under this scenario, cash appears
to be king. So, are financial markets in for a rough ride in
coming months? Marc, let's hear from you first.
Marc: Since October
2002, all asset markets have been inflated, some more than others.
Since the end of 2005, the technical position of the S&P
500 has been deteriorating and a significant correction is now
likely to be under way. Emerging markets such as Russia, India,
Brazil, Turkey, which had huge run-ups and became horribly overbought,
are now very vulnerable. Industrial commodities such as copper
are also vulnerable. In the last 100 years, there has never been
a three-year time period during which, such as has been the case
in the last three years, copper prices have risen by compound
70 per cent per annum. I am at this point less interested why
markets are declining than by what the markets are signalling
to the world by going down.
William: I supported a sell-in-May-and-go-away
policy in a previous BT Roundtable. Until early May, almost all
asset classes were priced for perfection floating in a sea of
complacently, assuming the continuation of a 'Goldilocks scenario'
of low interest rates, low inflation, high growth rates and stable
exchange rates despite record global imbalances.
This was obviously unsustainable: the massive injections of liquidity
were slowly being withdrawn. Meanwhile, the Middle East remains
unstable, the dollar is overvalued, inflation is increasing and
doubts are growing, as we predicted, about Bernanke's competence
to handle his brief. The G-7 meeting by indicating a desire for
a managed depreciation of the dollar helped upset the old equilibrium.
With so much leverage in the markets, the potential for ugly
corrections over the summer is high. The situation resembles
in many ways that of the summer of 1987 before the last market
crash that, ironically, was Bernanke's predecessor Alan Greenspan's
baptism of fire a few months after taking over the Fed. Other
problems that could come to the fore are those with derivatives
and the unwinding of the yen carry trade.
Christopher: This is a healthy bull market correction
for Asian equity markets and commodities which could last over
the summer. The correction will be worse if there is a real inflation
scare on Wall Street to test Bernanke.
Anthony: How long has it been
since we saw a conjunction like the present one, in currency
and financial markets - and is there still any chance of a soft
landing?
William: There are two similarities I can
think of with today's position. Unfortunately, they give two
different outcomes as possibilities.
The first is 1987, which I mentioned earlier which was a delayed
response to liquidity tightening by the Fed and an adjustment
of the dollar following the Louvre accord. The Dow lost 25 per
cent in a couple of days. Greenspan flooded the system with liquidity
and the market quickly recovered and went to new highs.
The other occurrence is 1973, when the Dow finished its recovery
from the 1969-70 bear market, created a double top at 1,000 and
then proceeded to lose 45 per cent of its value over the next
two years. That was accompanied by a sharp decline in the dollar,
the Yom Kippur war, a massive percentage increase in oil prices,
stagflation, Watergate and a bull market in gold. The period
included the installation of Arthur Burns, another academic like
Bernanke, as the new head of the Federal Reserve Board.
I think there is a significant likelihood that the US dollar
has to decline 30 per cent on a trade-weighted basis over the
next two or three years. If global geopolitical events intervene,
then the probability that this will be a hard landing is quite
high. We have a huge hidden problem with derivatives, which could
explode at any time. With problems in the Middle East and the
likelihood that the Republicans will lose Congress in November
means a replay of the Watergate years is a definite possibility.
If these events come to pass, then the 2003-06 recovery in the
US markets will be seen as a rally in a bear market that began
in 2000, and the bear market in the US is about to resume. Given
the geopolitical background, I believe this is a higher probability
outcome than the first postulate in the medium term.
Marc: We had in the S&P the third longest rise on
record without a 10 per cent correction. A correction/bear market
was long overdue. Obviously when asset markets will decline,
the US Fed will try to cushion the damage by 'printing money'.
This may not help the economy but would at least prevent equities
from tumbling. Stagflation will then likely occur.
Christopher: There can still be a soft landing in the
US. Much will depend on whether the Fed retains the confidence
of foreign creditors.
Anthony: Specifically, how
you see the outlook for equities in a) mature markets and (b)
emerging markets.
Marc: As I said, I regard for the next
three to six months emerging markets, which have significantly
out-performed the US in the last three years, to be more vulnerable
than the US. Some emerging markets such as Malaysia, Thailand
and Taiwan would seem - thanks to their high dividend yield -
to be less vulnerable than others. I may add that some emerging
market currencies - Turkish lira, Brazilian real, Mexican peso
- would also seem to be vulnerable.
Christopher: I think Wall Street is still in a secular
bear market, Japan and Germany are my favourite developed equity
markets. For Asia and emerging markets, my view remains firmly
that they remain in long-term bull markets.
William: In developed countries, markets have recovered
from the bear market of 2000-3 and valuations are generally on
the high side of fair in the US, but without the manic valuations
of 2000. Japan and Germany are recovering with Japan the more
convincing case. There is a case for exposure there since the
currency is also likely to be supportive. Since I expect volatility
and I do not like the US dollar's prospects, I would severely
underweight the US equity market and wait for better prices.
I would remain over-weight Asian emerging markets but would do
some reallocation around the region to recognise geopolitical
risks. Regardless of everything, it will remain the fastest growing
region in the world and people in developed economies around
the world worried about their pensions must participate in this
development. They remain underweight the region.
Sure, Asian emerging markets got a little ahead of themselves
before the recent sell-off but I look on India as a decade play
and below 10,000 on the Sensex should be owned. Taiwan and Korea
are longer term growth and recovery plays. Taiwan is following
the Japan recovery story and Korea is in the early stages of
a recovering market after breaking out of a 17-year trading range.
Malaysia is safe, boring and represents good value. Singapore
and Hong Kong are stable and have some very good companies.
Latin America is another story, in which I claim little expertise.
It appears to be going through one of its cyclical swings to
the left. It will end badly for the economies and in the interim
will not be good for their equity markets.
Anthony: What about the outlook
for bond markets?
Marc: Long term I am extremely negative
about US government bonds. In fact, each Singaporean should just
buy one US 30-year treasury bond, frame it, and put it on the
wall of his living room, in order to show his grandchildren how
the US dollar and US dollar bonds became worthless over time.
Still, for the next three months, I think US government bonds
could rebound because the economy is likely to badly disappoint
as a result of a sharply weakening housing market. So, whereas
equities outperformed bonds since 2003, for the next three months
bonds are likely to outperform equities. But this is a short-term
call. Long term, with one money-printer - an academic - at the
Fed and another money printer - from Wall Street - at the Treasury,
what can you expect?
William: Bond markets represent better value than they
did at the beginning of the year. But while inflation is still
increasing, they are still a gamble. If long US rates increase
by a percentage point, to closer to 6 per cent, then they would
be still more interesting. Until then, investors should hold
short-duration issues.
Anthony: Let's turn to commodities,
which have been the darlings of the market until recently but
now look like the Cinderellas.
Marc: Industrial commodities are likely
to sell off as the economy begins to disappoint. Don't forget
that within secular bull markets, 30 per cent to 40 per cent
corrections are not unusual. I also think gold will decline near
term, but since it is more of a monetary asset than dependent
on industrial production growth, I suppose that gold will outperform
other industrial commodities. I still like the grains, which
may outperform for a while. I would accumulate gold on any decline
because with the money printers in the US administration, its
bright future is assured. Long term, commodities - following
a massive correction - are, however, likely to outperform the
Dow Jones for many years.
Christopher: If commodities continue to correct, there
is a real chance that the US bond market will not break the long-term
trend line on the 10-year Treasury, which it tested at 5.2 per
cent earlier this month. But a renewed surge in commodities will
make bonds very vulnerable.
William: Gold and other precious metals have had a healthy
shakeout but their bull markets remain intact. They remain a
critical anchor to portfolios in the volatile times ahead.
The fundamental story on other commodities remains in place,
whether energy, minerals or agricultural commodities. Prices
are catching up with demand after years of underinvestment. However,
there is also no denying that hot money has entered these markets
and blown some of them to levels unsustainable in the short run.
Hence, the increased volatility, which we can expect to be maintained
going forward.
Anthony: What about the outlook
for currencies?
Christopher: Modern central bankers, most particularly
at the Fed, have only targeted asset prices on the downside in
recent years. This asymmetry will ultimately lead to the destruction
of the US dollar paper standard. For this reason I dislike the
US dollar fundamentally. My favourite paper currency is the Singapore
dollar.
William: My anxiety about the US dollar is known and is
compounded by the fact that we may be at a turning point in history
about the use of the US dollar as the sole reserve currency of
the world. The portents are all there: central bank nervousness
leading to a quiet diversification of reserves into other currencies
and asset classes. But more than that, talk by the Russians and
other oil powers of pricing oil in non-dollar currencies. Both
the Russian rouble and the euro have been mentioned. The Russian
oil bourse is set to begin rouble-based oil trading in June.
The Teheran bourse is also mooted. Events like this cannot be
shrugged off - they are highly significant. I have quoted Paul
Volcker and others who say that the US dollar needs to decline
substantially to reduce its current account deficit to a sustainable
level.
To reduce the deficit to a level of 3.5 per cent of GDP (which
is still on the high side of sustainable) would require a devaluation
of the order of 30 per cent against a basket of currencies. That
can only be accomplished through an appreciation of the major
Asian currencies as well as the developed country currencies.
I believe investors need to get out of the US dollar and into
the euro, AUD, yen, Sing dollar and Malaysian ringgit. A euro
of 1.40 and a yen of 100 by the end of the year are quite possible.
Marc: Six months ago, I made a case for a weaker US dollar.
The US dollar is from a longer perspective a doomed currency
- that should be clear to anyone with any brain, except of course
to Asian central bankers who continue to accumulate US dollars.
Still, near term, as with my point about US bonds, the US dollar
could hold or even rally somewhat. This is, however, a very low
confidence bet. With gold prices expected to decline further,
the US dollar would obviously also rally against gold for a little
while.My favourite paper currency is the Singapore dollar. -
Christopher: I may add that the position of the
US dollar depends entirely on the US Fed. If the Fed prints money,
asset price declines are cushioned but the dollar goes down.
If Fed tightens further, asset prices decline - dollar strengthens.
Since I am blessed not to work in the US administration, I cannot
give a precise answer.
Anthony: So, is a super-defensive
investment posture called for at this time?
Christopher: No. A hedged portfolio is advised. My recommended
global portfolio for a US dollar-based investor would be: 5 per
cent in German physical property, commercial and residential;
20 per cent in Japanese equities, weighted according to my Japan
thematic portfolio; 15 per cent in Asia ex-Japan equities, weighted
according to my Asia ex-Japan thematic portfolio; 5 per cent
in Asian physical property, including Japan; commercial and residential;
15 per cent in unhedged gold mining stocks; 10 per cent in gold
bullion; 20 per cent Singapore dollar cash; 10 per cent Japanese
yen cash.
Marc: I'm not sure there is such a thing as a defensive
position, when the bubble is the entire overblown asset market
and financial system. Super defensive would imply that there
is a way to short the US administration. That aside, I still
like Asian real estate and farmland, and, as mentioned above,
I feel comfortable to accumulate gold - ideally between US$550
and US$600. Food, pharmaceutical, tobacco and beverage stocks
would seem to be defensive.
William: Portfolios should always be tailored to the investor's
risk profile. Since we are transitioning from a bull market to
something more volatile and uncertain, it is certainly time to
do a stock-taking, and for many that will mean risk reduction.
But the portfolio must be structured to withstand many conflicting
storms and currents: stagflation, devaluation, war and geopolitical
turmoil as well as the sunny uplands of economic growth. It doesn't
mean hiding in cash. That is a part of a diversified portfolio,
but you also have to pick the right currency.
Anthony: Thank you again,
gentlemen for imparting your wisdom to us.
I'm sure we can all profit from your advice.
KEY POINTS
Emerging markets such as Russia, India, Brazil, Turkey, which
had huge run-ups and became horribly overbought, are now very
vulnerable.
Asia is likely to remain long-term bull markets.
While inflation is still increasing, bonds markets are a gamble
though they represent better value than they did at the beginning
of the year. Long term, commodities - following a massive correction
- are likely to outperform the Dow Jones for many years.
10 June 2006
William R. Thomson
wrthomson@btconnect.com
321gold
Inc
![](../../images/home2.gif)
|