It's a slow Thanksgiving Friday, and I decided I would rather be writing to you than shopping in the malls. In fact, I would pay good money not to go to the malls today. Which my kids think I am because they pointed out on Thanksgiving the amazing values I am missing, particularly on items they think should be on my Christmas shopping list. And I agree, I am surprised by the level of discounting, and believe those prices will be there in a few weeks when I actually get around to shopping. (Parenthetically, if holiday sales are strong but prices are lower [and they do seem to be!], what will that do to profits?) So, rather than participate in a shopping frenzy, let's ponder on the value of all those dollars my fellow citizens are spending today.
At the New Orleans investment conference last week, there were several constant themes. Gold, of course, would continue its rise. And the dollar would fall. The only variants on the latter theme were, by how much and when and against what. And as if on cue, the dollar made a 19-month low today as gold started to once again attempt to assault its recent highs. Today we look at the dollar from a longer-term perspective, see how this relates to global liquidity, and let you in on a running debate I am having with a few colleagues.
But first, a quick note from my partners in London. They (Absolute Return Partners) are looking for a hedge fund research analyst. If you are interested, you can either drop me your resume and I will forward it, or you can reach Nick Rees at www.arpllp.com.
It's All About Your Time Frame
In February of 2002, I turned bearish on the dollar and bullish on gold, for a variety of reasons. Up until that time gold had been in a 20-year slump, and the dollar was quite strong, especially against the euro. Back then it was well below $.90, and today it hit $1.31. From its all-time low of $.82, the euro has risen by over 50%. If you look at the chart since July of 2001, it has been rather a disaster for the dollar.
The dollar bear market has been one where the market moves sideways and then makes a solid leap, then spends more time going sideways before it makes the next move. Looking at the chart below, it looks like the dollar may be getting ready to make its next move. It has broken out of its 6-month trading range of $1.25 to $1.29, gapping to $1.31.
(Charts courtesy of my good friends at www.decisionpoint.com, one of my favorite sites for charts of all types.)
If you just look at this chart from the beginning of 2002, it looks like a move down in value for the dollar. But the last five years is not the whole story. Let's stretch the time frame out and go back to 1995. That chart shows a much different look. What we see is that the euro dropped in value (precipitously!) and then began to climb back. It is roughly where it was 12 years ago.
Yes, the euro did not exist back then, but this valuation reflects a basket of European currencies reflective of the value of the current euro. The euro was officially introduced in January of 1999 when the currencies of the various participating countries were irrevocably fixed to the euro. The introductory price was $1.17, and the euro almost immediately began to fall against the dollar.
Since the creation of the euro almost 8 years ago, it has risen about 12%. Many of the most aggressive and vocal dollar bears were bearish on the dollar all throughout the '90s. The fact that they have been right for the past five years may help them feel somewhat vindicated, but from a longer-term perspective it has been a boring trade.
And it is not just against the euro. If you take a look at the dollar index in the next chart, you see the same picture. After gaining almost 50% in value against a broad basket of currencies of our trading partners, we are basically back to where we were 12 years ago.
Notice that the index is a trade-weighted basket of currencies. There are some significant differences within the currencies in that basket. The dollar may be flat against the euro over the last 12 years, but it is down sharply against the Canadian dollar, the yen, and the British pound. It is up against the Mexican peso, and basically even since the Chinese fixed their currency to the dollar.
In previous cycles, the recent drop of the dollar would be a cause for inflationary concerns, as the price of imports should be rising. And while inflation did stage a modest comeback, the cause was not the increased price of imports. In fact, as we led off with, many of the prices of the things we buy have come down, even as our currency has fallen. For that we can thank Wal-Mart, Home Depot, etc., as well as China and scores of developing countries who manufacture items at increasingly lower costs.
The point is that we could see another drop of 10-20-30-% in the dollar, and for most of us it would not change a great many things. It would not be the end of the world. And it would make US products more competitive. So, take the gloom and doom about the dollar with a grain of salt. We have seen rather large gains and large drops in the dollar in the recent decades, and most US citizens have not noticed anything, or changed their habits. Watching the housing market or the stock market drop 20% would be far more personal to US consumers.
It's Different This Time
I hate the words, "It's different this time," because it almost never really is. But this time, globalization has changed the nature of the game. At other times in history, based on such a large and growing trade deficit, the dollar would have collapsed. But it has not. In every other country and currency in the history of the world, a trade deficit in the 5-6% range meant a 30% correction. We blew through 5-6% a few years back. We are looking at an unprecedented 8% next year.
I have written about the reason in past letters. Foreign governments, principally Asian, sell us goods and then buy our bonds, an off form of vendor financing. And this can go on for quite some time, as it is in no one's interest to stop the music. Or at least not stop it abruptly.
China and the rest of Asia will keep the game going until they have developed their own consumer markets, and the loss of the US markets will not be the body blow that it would be today. And when they do move, it will be slowly. The Chinese have made it clear that they will revalue and then float their currency over time, but the key point is that it will at a time and period of their choosing.
Yes, over time the world will decide it has too many dollars and the dollar will drop enough to affect the trade deficit. But waiting for that event so you can profit from a falling dollar may be frustrating. There are other opportunities for profit which may be better uses of your time.
That being said, I am still bullish on gold. I am not a gold bug, but simply see gold as a neutral currency. Is another 30% move in gold over the next few years possible? It would not surprise me. But it will move as it has for the past five years, in fits and starts.
Debt Is Leaving the US
While others are concerned about the trade deficit and see it as the great weight on the dollar, there may be more structural concerns. It is our capital markets that have been our strength. But that dominance is fading all too rapidly. The US is losing its role as financier to the world. Look at this most disturbing chart from the November 23 Economist.
Europe (!) has seen its share of corporate debt financing grow as the US portion has dropped, and the trend is decidedly not in the favor of the US. Even more ominous is the next chart, which shows that the percentage of new IPO proceeds from the US is rapidly dropping and Hong Kong (!) is doing almost as much as the US.
This is clearly the result of a combination of the legislative sausage known as Sarbanes-Oxley and other markets in the world (especially London) becoming more competitive as we become less so. Since the Democrats lay claim to this overzealous piece of legislation, perhaps they will now review how harmful it is to our country. The charts make visible the trending deterioration of the US capital markets.
But this also helps to partially explain (at least to me) why capital is going to Europe and why the euro and especially the British pound are strong. The US would do well to look at the British regulatory regime and see why so many companies are going there. I am personally registered in England and have seen my business there grow rather substantially this year. I think it is fair to say that those of us with registrations in both countries appreciate the way the English run their systems.
By the way, the Economist article makes clear that foreign companies still raise money here in the US. Ninety percent of the companies which have dropped their "cross-listing" still raise money on a private basis here, thereby avoiding the cost of being registered publicly.
Dennis Gartman's Rules of Trading
Every year at this time, good friend and trading maven Dennis Gartman publishes his "Rules of Trading." This year they are more succinct than ever, and I am taking the liberty of reprinting them here because, simple though they may be, they are also profound. Dennis has come by some of the rules the hard way, and it pays us to learn from his long and successful trading career.
DENNIS GARTMAN'S NOT-SO-SIMPLE RULES OF TRADING
1. Never, Ever, Ever, Under Any Circumstance, Add to a Losing Position... not ever, not never! Adding to losing positions is trading's carcinogen; it is trading's driving while intoxicated. It will lead to ruin. Count on it!
2. Trade Like a Wizened Mercenary Soldier: We must fight on the winning side, not on the side we may believe to be correct economically.
3. Mental Capital Trumps Real Capital: Capital comes in two types, mental and real, and the former is far more valuable than the latter. Holding losing positions costs measurable real capital, but it costs immeasurable mental capital.
4. This Is Not a Business of Buying Low and Selling High; it is, however, a business of buying high and selling higher. Strength tends to beget strength, and weakness, weakness.
5. In Bull Markets One Can Only Be Long or Neutral, and in bear markets, one can only be short or neutral. This may seem self-evident; few understand it however, and fewer still embrace it.
6. "Markets Can Remain Illogical Far Longer Than You or I Can Remain Solvent." These are Keynes' words, and illogic does often reign, despite what the academics would have us believe.
7. Buy Markets That Show the Greatest Strength; Sell Markets That Show the Greatest Weakness: Metaphorically, when bearish we need to throw rocks into the wettest paper sacks, for they break most easily. When bullish we need to sail the strongest winds, for they carry the farthest.
8. Think Like a Fundamentalist; Trade Like a Simple Technician: The fundamentals may drive a market and we need to understand them, but if the chart is not bullish, why be bullish? Be bullish when the technicals and fundamentals, as you understand them, run in tandem.
9. Trading Runs in Cycles, Some Good, Most Bad: Trade large and aggressively when trading well; trade small and ever smaller when trading poorly. In "good times," even errors turn to profits; in "bad times," the most well-researched trade will go awry. This is the nature of trading; accept it and move on.
10. Keep Your Technical Systems Simple: Complicated systems breed confusion; simplicity breeds elegance. The great traders we've known have the simplest methods of trading. There is a correlation here!
11. In Trading/Investing, An Understanding of Mass Psychology Is Often More Important Than an Understanding of Economics: Simply put, "When they are cryin', you should be buyin'! And when they are yellin', you should be sellin'!"
12. Bear Market Corrections Are More Violent and Far Swifter Than Bull Market Corrections: Why they are is still a mystery to us, but they are; we accept it as fact and we move on.
13. There Is Never Just One Cockroach: The lesson of bad news on most stocks is that more shall follow... usually hard upon and always with detrimental effect upon price, until such time as panic prevails and the weakest hands finally exit their positions.
14. Be Patient with Winning Trades; Be Enormously Impatient with Losing Trades: The older we get, the more small losses we take each year... and our profits grow accordingly.
15. Do More of That Which Is Working and Less of That Which Is Not: This works in life as well as trading. Do the things that have been proven of merit. Add to winning trades; cut back or eliminate losing ones. If there is a "secret" to trading (and of life), this is it.
16. All Rules Are Meant To Be Broken.... but only very, very infrequently. Genius comes in knowing how truly infrequently one can do so and still prosper.
New York, The World, and a Really Bad Movie
I head for New York on Sunday with my associate and daughter Tiffani to hold a quick one-day meeting with some of my business partners from the US, Europe, Switzerland, and Canada. It is a smorgasbord of firms going by their initials: ARP, EFG, CMG, SCM, with Stuart McKinnon of Pro-Financial in Toronto being the exception to the initial trend this trip. I expect to make some announcements within the next few weeks, not only of new projects and investment services, but also of areas of the world that we can service. I am very excited about the coming year.
Next year I expect to do a lot more traveling than this year. My partners in London want me to get to Europe at least twice if not three times. I already know I am speaking in Copenhagen in August, and I want to get to Australia and find a partner in that part of the world. It is one of the last places I do not have a partnership with a firm, and I have a lot of readers from down under.
Last night I got talked by my family (kids, sister, brother, nephews) into going to see a new movie called The Fountain. I wanted to go see the new Bond flick, but I got voted down. I knew it would be something of a romance, but it was sold to me as part sci-fi, so I agreed to go along.
As 10 of us walked out of the movie, there was unanimous agreement that this was easily on everyone's list of five all-time worst movies, with some making it their all-time worst. While visually impressive, it was so incoherent and its plot so convoluted as to be simply incomprehensible.
There appear to be some good movies coming out, and my family does enjoy going to the movies. Just thought I would warn my movie-going readers. Just another service from your humble analyst.