GOLDMAN SACHS IS WRONG; THE U.S. DOLLAR IS IN A DOWNTREND WHICH WILL ACCELERATE (October 30, 2015): Goldman Sachs (GS) announced on Thursday, October 29, 2015 that the U.S. dollar would achieve parity with the euro before the end of 2015. Goldman Sachs is also bearish toward the currencies of commodity-country and emerging-market currencies including the Canadian and Australian dollars, expecting the loonie and aussie to retreat significantly versus the greenback during the next several months. Goldman Sachs believes that the price of crude oil will plummet to 20 U.S. dollars per barrel and that gold will slump below one thousand U.S. dollars per troy ounce. What the above outcomes all have in common is the anticipation of intensifying deflation and a surging greenback, along with continued declines for commodity prices. It is interesting to note how bullish Goldman Sachs was toward all of the above during the first half of 2008, just before they all plummeted by historic percentages within less than a year. More importantly than their track record, however, is the logic which is used by Goldman Sachs and many other analysts to justify their expectations for a stronger U.S. dollar and lower commodity valuations.One popular myth is that currencies with rising interest rates will outperform those with falling interest rates. If the U.S. Federal Reserve is considering raising the overnight lending rate, while the European Central Bank is considering lowering it, then supposedly this means a higher U.S. dollar versus the euro. However, it usually works the opposite way. Emerging-market currencies have among the highest interest rates in the world, and their currencies have slumped versus the greenback especially when their rates were ascending the most. Rate increases generally reflect an anticipated rise for inflation, and global investors tend to avoid countries with rising wholesale and retail inflation which will erode the value of their holdings. Therefore, it is often the countries where rates are declining that will attract the strongest worldwide inflows. Those emerging markets where interest rates have been slashed the most in recent weeks have generally enjoyed the most powerful rebounds in their currencies.
One measure of purchasing power parity can be achieved by calculating how much it costs in U.S. dollars to buy a particular item which is virtually identical around the world. For example, a Big Mac at McDonald's (MCD) in one country is essentially indistinguishable from a Big Mac ordered in a McDonald's in a completely different continent. Therefore, you would expect their prices to be almost identical, but there are actually substantial differences in price in varying cities. Wherever the prices of Big Macs have been cheapest in past decades, the currencies later climbed higher; where the Big Macs were most expensive, the currencies retreated in price. This didn't always happen immediately, and sometimes the extremes first became even more extreme, but eventually there was some kind of global parity. Currently, the cheapest Big Macs are in emerging-market economies. Below-average prices can also be found in countries with high ratios of commodities to people including New Zealand, Australia, and Canada.
Some emerging-market and commodity-country currencies recently slumped to their most depressed levels in history versus the U.S. dollar, while others fell to their lowest points in many years. In the middle of March 2015, the U.S. dollar index climbed to a 12-year top. Extremes can often become even more extreme, but a scan of brokerages and other institutions shows that nearly all of them are on the same side as Goldman Sachs even if their short-term forecasts are less drastic. Almost all of them are expecting a generally rising U.S. dollar, and almost all of them are also expecting lower prices for commodity-related assets including currencies of commodity-producing countries, the shares of commodity producers, and commodities themselves. Any nearly unanimous consensus generally proves to be wrong sooner or later, because everyone trades on the same side in anticipation of a particular outcome which thereby makes such an outcome much less likely to occur. For example, if nearly all futures traders are expecting a higher U.S. dollar, they will have already bought a large quantity of greenbacks. This leaves far fewer new potential buyers, while many who had bought U.S. dollars in anticipation of higher prices will be in position to sell them whenever they become disenchanted with their failure to behave as had been expected.
There is an intuitive emotional tendency to project the recent past into the indefinite future, especially when recent behavior has remained generally consistent for an extended period of time. If there has been a bear market for several years or more, then one begins to take for granted that it will continue for several more years. Most emerging-market currencies and equity markets had peaked during or near April 2011, and therefore had been in bear markets for more than four years by the time that these assets completed historic bottoms during the past summer or early autumn. It is possible that some commodity-related assets haven't yet achieved their ultimate nadirs for the cycle, although their patterns consisting mostly of higher lows during the past several weeks tend to signal that their trends have already reversed. Looking at charts of natural gas producers (FCG), gold and silver mining companies (GDX, SIL, and GDXJ), and Latin American equities (ILF, EWZ, and GXG), these vary somewhat but all have in common that 1) they lost dramatic percentages since April 2011; 2) they reached multi-year, multi-decade, or all-time bottoms from July through September 2015; and 3) following their respective bottoms, they appear to have formed several higher lows in the kind of choppy trading with frequent corrections which tends to characterize the early months of any powerful bull market. Media and analysts' coverage has remained almost universally gloomy toward all of the above securities with very few agreeing that these and similar assets may have begun important bull markets. The most common explanation by many bearish analysts is that since those who are bullish have been wrong recently, they will continue to be wrong. Similar arguments would lead to not buying near the bottom for anything, because those who have been bullish will always have been recently "wrong" at any nadir.
Because most U.S. equity indices have rebounded smartly in recent weeks, many investors and analysts have concluded that their corrections are over and that the next few years will enjoy frequent new all-time highs. I think this is a seriously flawed conclusion, since we have experienced classical divergences which generally indicate that we are already in a bear market. Fewer stocks have been able to accomplish new all-time highs than had been the case a half year ago, while indices of the smallest companies are still trading below their levels from early March 2014 which was more than 1-1/2 years ago. Just as in 2007-2009 or 2000-2002 or 1973-1974--or any past severe bear market--investors aren't worried about the possibility of the existence of a bear market, figuring that all corrections are good buying opportunities and that new all-time highs for the S&P 500 (SPY), the Nasdaq (QQQ), and the Russell 2000 (IWM) must lie just around the corner. Thus, the vast majority of participants are convinced that the U.S. stock market is still rising and that the U.S. dollar is doing likewise, even though both have probably already begun important downtrends. There are many brokerages and analysts which have forecast the price of gold to drop by roughly 150 U.S. dollars per ounce or more, while almost none of them expect the gold price to rise by a similar amount. Whenever almost everyone is aligned on the same side of any trade, the opposite almost always occurs so that the majority of investors repeatedly end up losing money.
Many media commentators and others misinterpreted the Fed's latest rate announcement. The Fed declared that they would decide at the next meeting about whether or not to raise the overnight lending rate--but nearly all analysts left out the second part of this statement which explicitly stated that they would only do so if inflation had reached or exceeded two percent. Regardless of what happens between now and December 2015, there are very few scenarios where the rates of inflation which are tracked by the Fed for this purpose could realistically surge to 2.0% or above. Therefore, the Fed isn't announcing that they might raise rates at the next meeting--they are telling you why they aren't going to do so! I didn't see a single media outlet explaining this in its proper detail.
As a result, all of the deflationary forecasts by Goldman Sachs will prove to be as misguided as their inflationary predictions had been in 2008 and 2011. Gold (GLD) will rally instead of retreating to one thousand, crude oil (USO) will similarly climb, and nearly all other commodities including metals (XME) and energy assets (XLE) will recover half or more of their losses which they had suffered in recent years. Emerging-market assets (EEM), which had also experienced severe multi-year percentage declines, will enjoy analogous rebounds. The U.S. dollar (UUP), which is widely expected to resume its former uptrend, will instead retreat to a multi-year bottom versus most global currencies including the Canadian dollar (FXC) and the Australian dollar (FXA). I am less of a fan of the euro (FXE) or yen (FXY), but even these two popular currencies will move higher versus the U.S. dollar as investors become increasingly eager for alternatives to a sliding greenback for the remainder of 2015, probably for most or all of 2016, and perhaps into early 2017.
Disclosure: In August-September 2013, and at various points during 2014-2015, I have been buying the shares of emerging-market country funds whenever they have appeared to be most undervalued. Since June 2013, I have added periodically to funds of mining shares--and more recently energy shares--especially following their most extended pullbacks. I have also been accumulating HDGE whenever U.S. equity indices are near their peaks; HDGE is an actively-managed fund that sells short U.S. equities. I believe that U.S. assets of almost all kinds have become dangerously overvalued. From my largest to my smallest position, I currently own GDXJ, KOL, SIL, XME, HDGE, COPX, GDX, EWZ, RSX, REMX, GLDX, URA, FCG, IDX, GXG, VGPMX, ECH, VNM, BGEIX, NGE, RSXJ, PLTM, EPU, TUR, SILJ, SOIL, EPHE, and THD. In the late spring of 2014, I sold all of my SCIF which had briefly become my fourth-largest holding, because euphoria over the Indian election was irrationally overdone and this fund had more than doubled. I have reduced my total cash position to roughly 3% of my total liquid net worth in order to increase my holdings in the above assets. I sold all of my SLX by acting whenever steel insiders were doing likewise. I also sold all of my FCG when insiders were unloading, but I repurchased FCG in recent months following its collapse of more than three fourths of its June 2014 peak because there had been intense buying by top corporate insiders of companies which produce natural gas. I expect the S&P 500 to eventually lose about two thirds of its May 2015 peak valuation, with its next bear-market bottom occurring within several months of October 2017. The Russell 2000 Index and its funds including IWM had only modestly surpassed their highs from the first week of March 2014, while the Russell Microcap Index (IWC) marginally surpassed its zenith from March 6, 2014. The S&P 500 Index set a new all-time high on numerous occasions during the same period, and may have completed its final top for the cycle at 2134.72 on May 20, 2015. This marks a classic negative divergence which previously occurred in years including 1928-1929, 1972-1973, and 2007. Those who have "forgotten" or never learned the lessons of previous bear markets are doomed to repeat their mistakes.
Do YOU engage with media from mainstream corporate sources such as Goldman Sachs, and if you do, how does the information you find factor into your overall opinions?
EMAIL sjkaplan@truecontrarian.com with your answer.
