Why Are Investors Returning to the Dollar?

by: Joseph Shaefer October 19, 2008 | about stocks: AA / AU / CEF / CHK / DIA / FCX / GCI / GDX / GG / GLD / JOYG / QQQQ / SPY / TEX / X    

Joseph L. Shaefer


Why is the U.S. dollar so strong, given the trillions of dollars the Treasury is borrowing and printing?

Because when the lights go out, you’d like to be at home. You know where all the furniture is, even in the dark. It’s the same with investing. When a panic hits, and U.S. investors look to raise their cash positions, they act predictably – and perhaps rationally. Let’s say, for simplification and illustration, you are an American and you own just three stocks. One is a U.S. diversified energy exploration and regulated utility holding company, the second is the same type of firm in India, and the third is the same type of firm in RSA – South Africa. When there’s blood in the streets, where are you most comfortable investing? At home or abroad? Where, when you need current news the most, do you expect to find the fastest information about your holdings? In your home country or abroad? 

Most of us would answer that question: “In the U.S.” I spent 30 years in the Intelligence Community as, among other things, a geopolitical analyst, so I might answer the question differently. But for most of us, Dorothy had it right: “There’s no place like home.” As a result, the facts show that Americans are repatriating their dollars held overseas at a record rate and, indeed, are even selling US-traded ADRs of well-established and highly-regarded foreign firms.

We know we have the best politicians and regulators that money can buy (!) and, however bad things are here, the niggling suspicion is that things are probably worse “over there.” So zlotys and yuan are being exchanged for dollars at a rapid pace. And not just any dollars, Johnny. We are buying U.S. Treasuries at such a clip that the yield for 30-year Treasuries has declined to 4.31%. Some people are willing to believe that 4.31% will keep them ahead of inflation and taxes from now until 2038. For holding a 1-year Treasury, investors are OK getting just 1.28%. Anything to “preserve” their cash. After inflation and taxes, 1.28% will leave you with less than you started with but many believe, perhaps realistically, that keeping 97 or 98 cents for certain at least gives you 97 or 98 cents to buy the bargains later on when things are even cheaper.

So dollars keep coming home and going into Treasuries, making dollars more scarce as a unit of exchange for transactions like buying oil from Saudi Arabia or unwinding a CDS in Sweden. You can pay for your oil in Euros or Yen or Zimbabwean Dollars (well, for a teaspoon or two, anyway) but the price is figured in U.S. Dollars, so a strong dollar hurts everyone not using dollars as their primary mode of exchange. Add to this the fact that financial institutions worldwide now need U.S. Dollars. Why? Because much of the international financial chicanery is dollar-denominated and unraveling faster than a ball of yarn in the paws of a 6-week-old kitten. To pay off dollar obligations, it’s best to have dollars.

That’s the short reason why the U.S. Dollar is strong right now. But let’s talk about what comes next. We’ll sell our current buys some time in the future, be it tomorrow or 10 years from now, so it’s the future that interests me most. And there I see a radically different picture. The need for U.S. Dollars to unwind derivatives positions is temporary. The flight to Treasuries will abate. The U.S. will, regrettably, have a lessened role in international finance. Would you trust a bunch of unruly children who violated the rules of the playground with impunity – until they got caught? We’ll need to re-build credibility with responsible stewardship, solid corporate governance, and appropriate regulation.

Since the U.S. economic “miracle” created out of thin air and thinner derivatives during the “let’s keep the party going” years was based on easy credit, we need to show that we can extend credit to grow businesses and actually have a scintilla of hope that those loans will be repaid out of future earnings – not eternal home price appreciation or financial engineering from a bunch of quants who haven’t a clue about the real world of actions and consequences.

What do you do about it? You can panic and sell everything, you can buy Treasuries, or you can catch falling knives. I’m willing to accept some scarring from that last alternative as long as it leaves me with the world’s best knife collection. I know the strength in the U.S. Dollar has to be short-term. So as part of building my knife collection, I am doing three things:

For the Short term (2-6 months), I am gingerly stepping in and buying some U.S. stocks that are down 60, 70 and 80%. You can buy large-cap U.S. leaders today like Alcoa (AA), US Steel (X), Chesapeake Energy (CHK), Terex (TEX), Gannett (GCI), Joy Global (JOYG) and Freeport-McMoRan Copper & Gold (FCX) for 25-30 cents on the dollar. (Current price vs. high for the past 12 months.) Since money is coming back to the U.S. and since mutual funds have been pressuring these kinds of companies the first half of October, they’re often good for a fine rebound during the traditionally-stronger November-April seasonal time frame.

(A word on why the mutual funds are panic-selling now: most mutual funds have adopted October 31 as their “year-end” for realizing gains and losses. These portfolio managers, hoping not to be fired, are loathe to carry their bad performers into the “new year” beginning November 1. If I were a cynical sort just because I’ve been in this business for nearly 40 years, I might note, too, that their bonuses are based solely on what they do in a given “accounting year” so, like doctors, they can bury their mistakes in October and start brand-new fresh in November. With an incentive like that, why not sell everything now and buy back in November? But I am not a cynic. Just a realist.)

For the Intermediate term (6-18 months), I’m buying GOLD. I may be a bit early buying today since I believe the U.S. Dollar will need to adjust downward (a slam dunk, in my view) and oil will need to climb from current levels (a slam dunk, in my view) before gold makes a sustained move through $1000 on its way to $1500+. But at these prices it’s just too cheap not to begin positioning for the intermediate term. I like Goldcorp (GG), Freeport-McMoRan (FCX) and Anglo-Ashanti (AU) the best, but I’m also buying bullion via Central Fund of Canada (CEF) and SPDR Gold Trust (GLD) as well as stocks via Market Vectors Gold Miners (GDX) and a number of mutual funds. The world cannot borrow or print $4 trillion and not see inflation. Gold is the best way to protect yourself against inflation. Especially at these fire-sale prices.

For the Long term (18 months-Forever), I’ll buy The Market. “Buy when others are terrified.” They’re terrified. Hard as it is to put a few shekels aside for the distant future in such times, I’m buying the ETFs corresponding to the Dow (DIA), Nasdaq (QQQQ), and S&P 500 (SPY). If we’re quick, we can catch these by the handle, bolster or spine instead of the blade…

Disclosure: Currently long TEX, FCX, JOYG, GG, AU, CEF, GDX, DIA, QQQQ, SPY. Will be long others above over the next week…