Toro's Running of the Bulls Market Blog

Dollar to Lose Reserve Status - PIMCO

From Bloomberg

Pacific Investment Management Co., which runs the world’s biggest bond fund, said the dollar will probably fall as it loses its status as a reserve currency.

The dollar will especially drop against emerging-market counterparts, Curtis A. Mewbourne , a Pimco portfolio manager, wrote in a report on the company’s Web site. Investors should consider cutting their holdings of the U.S. currency, he said.

“While we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the U.S. dollar as a store of value even in the absence of a single viable alternative,” Mewbourne wrote

Though I agree that the US dollar is losing status and will continue to fall against currencies of fast-growing emerging nations, it is difficult to see any alternative to the dollar as a reserve currency in the foreseeable future.

Having said that, I am long gold, and expect to see gold hit new highs as all fiat currencies lose value relative to real assets.

Dollar Reserves Increase

Despite all the gnashing of teeth regarding the dollar ...

The IMF's authoritative Currency Composition of Official Foreign Exchange Reserves (COFER) report last week indicated that the dollar's share of global reserves (where the allocation is reported) rose to 65%, to stand at its highest since 2007.

Though one would expect diversification by central banks into other currencies simply as prudent portfolio management, the simple fact is that there is no credible alternative to replace the dollar, nor will there be for many, many years. 

Peter Schiff was Wrong

From Mish.

Schiff's Overall Thesis

• US Equity Markets Will Crash.
• US Dollar Will Go To Zero (Hyperinflation).
• Decoupling (The rest of the world would be immune to a US slowdown.
• Buy foreign equities and commodities and hold them with no exit strategy.

Schiff was correct about point number 1 above. The US equity markets crashed. That was a very good call. Unfortunately, his investment thesis centered on shorting the dollar in a hyperinflation bet, and buying foreign equities rather than shorting US equities.

Furthermore, Schiff made no allowances for being wrong and had no exit strategy whatsoever.

What happened in 2008 was that foreign equities sold off much harder than US equities, and a strengthening US dollar compounded the situation.

In other words, Schiff failed where it matters most: Peter Schiff did not protect his client's assets. Let's take a look how, and more importantly why, starting with charts of various foreign indices.

I've never understood the reasoning behind a dollar collapse. 

The US dollar is not going to collapse, at least not relative to other fiat currencies.  It cannot without doing enormous damage to the global economy.

Fiat currencies have a natural range by which they are bound.  If the dollar went to three against the euro, the American economy would boom because American goods and services would be enormously cheap relative to the euro.  Conversely, the European economy would collapse because their export markets would disappear. 

So no, the US dollar will not collapse against other fiat currencies.

Against real assets however...

UPDATE - EuroPacificCapital has responded.

Intraday Yen Chart

Take a look at what happened to the yen today.

The yen gained an astonishing 3 points in an hour this morning.

Unless someone can educate me otherwise, that, no doubt, is a very large carry trade (where one borrows in yen and invests in dollars) being unwound and jammed into the market.

Pondering the Euro and Precious Metals

The euro has achieved a 50% retracement of its move from $1.60 to $1.23.  I never got into my euro short call I made some time back.  I will be watching it closely for an entry point, which I suspect will be sometime in the new year as opportunities arise to sell stocks.

One has to be very heartened by the move in gold and silver if one is a precious metals bull.  If one shorts the euro against the dollar, I would not necessarily expect gold and silver to hold up.

Gold will go down if the world is in a deflationary spiral.  The gold perma-bulls/bugs are trying to have cake and eat too arguing that gold will rise in either an inflationary or a deflationary.  I think this argument is nonsense, and gold’s descent this year from $1032 to $682, and silver’s decline from $21 to $8 is indicative of what happens to precious metals during deflation.

However, I have always maintained that the end game for the precious metals would when nations are engaging in competitive devaluations of each other's fiat currencies against one another.  If so, then a rise in the dollar would not necessarily be met with a concurrent decline in gold and silver.

The Loonie and Oil

From Worthwhile Canadian Initiative.  The movement in the Canadian dollar was highly correlated to the movement in the price of oil.

Short the Euro

I have a philosophy on shorting.  Unlike buying and holding a stock because its cheap - if your analysis correct, valuation will always bail you out if you are patient enough - shorting is more complex.  High valuation is not enough to short, in my opinion.

Shorting is the process of borrowing a security then selling it in the hopes it will fall in value so you can buy it back at a lower price before returning the security to its rightful owner. 

In theory, losses from shorting are limitless, since the price of a security can theoretically rise forever. Practically, this does not happen since no stock rises to infinity.  However, a shorted stock price can rise enough to wipe you out.

Those shorting the ridiculously over-valued Talking Sock Puppets in 1998 based solely on valuation were harshly taught this lesson, as many short sellers were wiped out during the Tech Bubble as valuations grew from the merely ridiculous to the idiotically insane.

Thus valuation is not enough for me to short, though valuation is a critical component.  When stocks break, over-valued stocks will usually fall much farther than under-valued stocks.

Along with valuation, there are two other factors I look for when shorting - fundamentals that are or about to deteriorate, and a breakdown in the technicals.

Fundamentals are the foundation of a security's ascent.  Securities that are supported by strong fundamentals have a strong foundation.  However, like a house, deteriorating fundamentals are tantamount to the rotten foundation of a physical structure.  When the foundation collapses, so does the price of the security.

Technicals are a clue that buying power is exhausted.  When charts are rolling over, it is a sign that all the buyers have bought and there is no one left to support the security.  Deteriorating technicals are the safest sign that it is time to short, in my opinion.

A while ago, I called the bottom of the dollar.  I was wrong.  It still had another leg down.  However, I was close to the lows, which I believe are now in place.  I believe the dollar is about to strengthen appreciably against the other developed currencies, in particular against the euro. 

Over the next few weeks, I intend to get short the euro, though the currency is extremely oversold at the moment.  Thus, I will wait before entering my position.

A euro short satisfies all three factors of my shorting criteria.

Valuation
The euro is overvalued against the dollar.  Interest rate differentials are fairly benign for long-run instruments, though short-term rates are much higher in Europe.  However, inflation is peaking, which means that with economic growth slowing, interest rates will come down in Europe, and short-term interest rate differentials will narrow.

Based on purchasing power parity, the dollar is worth $1.10-$1.20 against the euro, according to several investment banks.  Having last been in Europe in March - when the dollar was hitting all-time lows and dropping over a penny a day - this seems about right to me. 

Fundamentals
Growth is slowing in Europe and business conditions are deteriorating.  The Spanish banking system is under extreme duress, having funded the housing bubble to excess which is now collapsing, Spain's banks are as bad, if not worse, than America's.  Ireland is also in trouble for similar reasons, and home prices are generally over-valued on the continent.  Meanwhile, German business confidence is eroding, hitting lows not seen in decades, the economy contracted in Italy during the second quarter, and France is, well, France!

Things are not necessarily worse in Europe than they are in America, but Europe has not yet experienced the significant deceleration already experienced in the US, and the currencies do not yet reflect the disparities in the growth curves.

And decoupling is sheer nonsense.

Longer-term, despite the slower growth that will occur in America over the next several years as excesses work through the economy, America's economy is more structurally sound as the US is more dynamic and pro-growth than Europe. 

Also, the demographics work against Europe as the rate of population growth is slower in Europe than in America.  Social Security and Medicare liabilities are enormous.  However, they are peanuts compared  to the future public pension and healthcare liabilities in Europe as the welfare state is far more generous on the other side of the pond. 

In Europe's favour is the inclusion of the former Warsaw Pact countries into the union.  This should not be underestimated as the cost structures are significantly lower in Eastern Europe, which will force radical restructuring on the continent.  This restructuring will be bitterly opposed in the political arena, but it is inevitable, and ultimately will lead to higher rates of economic growth.  This, however, is many years into the future.

Technicals
The euro is rolling over.

The huge move down on Monday was significant.  I think the chart is broken.

I will look to get aggressively short the euro in the not too distant future.

Euro as a Share of Global Reserves Declines

This might come as a bit of a shock to the Dollar-is-history-as-a-reserve-currency crowd.  Heck, I'm not one of those dollar-collapse guys, and it came as a surprise to me.

From the ECB via Alea blog.

The use of the euro in foreign exchange reserves held by third countries, i.e. countries outside the euro area, increased moderately by around 1½ percentage points during the review period owing to positive valuation effects. When measured at constant exchange rates, the share of the euro in global foreign reserves decreased slightly by almost 1 percentage point, mainly as a result of a decline in developing countries. ...

[The euro's] role gradually increased during the first few years of European Monetary Union but has been broadly stable for around five years.

Over those five years, the value of the euro has soared relative to the dollar, yet it has not been due to central bank buying of the euro.  One of the tenants of the dollar-collapse crowd was that central banks would dump dollars and buy other currencies.  That appears not to have happened.

The Dollar and Gold

There has been a whole lot of chatter about how gold is going to go down because the dollar may be bottoming.  We believe that there is a significant probability that the reflexive anti-gold/pro-dollar trade is wrong.  Gold has been in a bull market in all fiat currencies over the past 10 years, not just dollars. 

We here at Running of the Bulls are both bullish on gold and the dollar, though we think that we should start watching for a gold top in the not too distant future. 

First, it looks like the dollar may be bottoming. 

And over the past few weeks, gold has traded in the opposite direction of the dollar.  But gold has generally gone down less than the dollar has gone up.

In fact, as the dollar bottoms, gold may be consolidating.

The above chart looks like gold is drawing one of those wedge type chart thingies that gold has traced throughout its ascent over the past several years.

I have no idea if gold is on the verge of breaking down or not. But until we see proof otherwise, the bull market in gold is still on, even if the dollar has bottomed.

Surely a Top in the Euro

Stores in New York City have begun accepting euros.

In the latest example that the U.S. dollar just ain't what it used to be, some shops in New York City have begun accepting euros and other foreign currency as payment for merchandise.

"We had decided that money is money and we'll take it and just do the exchange whenever we can with our bank," Robert Chu, owner of East Village Wines, told Reuters television.

The increasingly weak U.S. dollar, once considered the king among currencies, has brought waves of European tourists to New York with money to burn and looking to take advantage of hugely favorable exchange rates.       

I am long the dollar.