Tuesday, July 26, 2011

"Wide diversification is only required when investors do not understand what they are doing." --Warren Buffett

HOLLER FOR THE DOLLAR (July 26, 2011): Judging from the e-mail flurry I have received in recent days, I can tell you something which will not be a huge surprise: the U.S. dollar is currently one of the least popular assets worldwide. Regardless of whether investors are bullish or bearish toward stocks, commodities, or real estate, they all seem to agree that because of U.S. budget and trade deficits, or due to structural problems with the United States economy, or for numerous other reasons, they believe the U.S. dollar will "continue to decline" until it plunges to a new all-time nadir sometime in the near future.

The reason I put "continue to decline" within double quotes is that the U.S. dollar index has actually been forming a bullish pattern of higher lows since March 16, 2008, which was nearly 3-1/2 years ago. This has to be one of the least-known bull markets on record. On that date, the U.S. dollar index touched an all-time record low of 70.698. The greenback made a higher low of 71.314 on July 15, 2008, and then more recently it completed an even higher bottom of 72.696 on May 4, 2011. At the present time, the U.S. dollar index is likely in the process of soon completing yet another higher low.

What is often forgotten by investors is that when the global economy began to contract in the second half of 2008 and into the early weeks of 2009, one of the prime beneficiaries was the U.S. dollar index, which surged to a three-year peak by early March 2009. The decline of the greenback which began on March 4, 2009 was one of the most reliable signals that worldwide stock markets would initiate a powerful rally, which is of course exactly what they did for roughly two years thereafter. While many believe that China or Switzerland or Japan or some other country has taken over the role of a safe-haven currency, none of the above or any other currency has proven itself during a period of economic crisis. Robert Frost said that home is the place where, when you have to go there, they have to take you in. The U.S. dollar is often derided when times are good, but when the going gets tough, investors will always crowd into the greenback because there's no other viable alternative which is sufficiently liquid and predictable and which has a proven track record of rallying when almost all risk assets around the world are slumping. When the world goes into a double-dip recession, the U.S. will of course suffer also, but it will be hurt less than almost everywhere else just as had been the case during the previous bear market.

The U.S. dollar has become oversold partly out of irrational fear over U.S. Congress reaching some kind of debt-ceiling agreement. It is almost certain that some kind of arrangement will eventually be achieved, and it will likely contain a combination of spending cuts and tax increases--precisely the scenario which is most bullish for the U.S. dollar. Gridlock in Congress has already resulted in a sharp drop for new spending, which is likely to continue into the indefinite future as long as neither party has the necessary preponderance of votes to be able to advance its pet agenda.

In many parts of the world, currencies have been held aloft due primarily to unsustainable housing bubbles in countries including India, Brazil, Russia, Canada, Switzerland, most parts of Scandinavia, Australia, and New Zealand. As those housing bubbles inevitably collapse, their corresponding currencies--all of which are incredibly popular today--will plummet in tandem with their real-estate prices. This will provide additional fuel to power the greenback higher as U.S. housing prices will likely drop by less in percentage terms than all of the countries listed above.

I strongly recommend that investors in any country seriously consider putting the vast majority of their assets into U.S. dollar assets or their equivalents. TLT is a fund of U.S. Treasuries averaging 28 years to maturity which is more volatile and unpredictable than a time deposit paying one percent, but is yielding approximately 4-1/4% and is much closer to its four-year low of 87.30 than its four-year high of 123.15.

The U.S. dollar index has not exceeded 100 since 2003--and I expect it to move above 100 again in 2013, thereby achieving a one-decade zenith. The more severe the upcoming global recession becomes, the more strongly the greenback will rally.