Enzio's Clock

Background

1. Super dollar declines, Gisele Bundchen's and Bill Gross' currency strategy

Just to pre-empt you subscribers who are solid in grammar: Gisele and Bill have the same currency strategy - although they may not converse so much.

On Wednesday, the dollar got sold off yet again. That has but everything to do with The Economic Time™ getting worse in America. Indeed, none other than Dr. Greenspan warned on Monday of plunging house prices and rising inventories of unsold homes. All of this follows America's biggest mortgage boom in history: from 2004 until last year, Americans borrowed US$2.9 trillion in new home loans; now, according to Dr. Greenspan, the financial system has to shed inventories of 200,000 - 300,000 homes!

So defaults are up. We all know that this boost in defaults is hurting banks and egos at their tops. We just wonder whether banks in Asia are so doggedly  that we never will find out the degree of their involvement...

Homes are important because they are the foundation of Maslow's pyramid of needs: once your shelter gets threatened, lots of other things get sucked into this vortex. Such as less spending - and less lending by gun-shy banks. Clearly, an excess demand for money is emerging from the credit side of the ledger this time, and this tightening cannot be alleviated by lower and lower Fed Funds rates.

But, US interest rates must keep declining: The Economic Clock™ is ticking "bad" more and more loudly. We suggested on Tuesday that Fed Funds normally rise for two years and then rapidly fall for about three years. Rarely have they been stuck at a high level for a long time. That is logical: higher rates are meant to create an excess supply of goods, so down goes the economy. So the Fed has to step in quickly and decisively to counter this excess supply of goods - by rekindling demand. This time around, the "different" bit is that housing prices are going to keep dousing consumer confidence, so expect Fed Funds to decline for a long time. All of which makes us curious as to why markets are jubilant when rates get cut - do some folks just not "get" why the rates are getting slashed?

All of which, of course, lessens the allure of the dollar. But there are structural reasons for its demise, too. In our ruminations on why superpower currencies must fail, we suggested that basically, the costs of maintaining an empire get too much, so the superpower government prints more money in order to pay the bills. Econ 101: if the supply goes up, and demand remains constant, the price drops. Nothing "different" this time around!

Take this one step further. What is meant by "costs of maintaining the Empire"? The key guzzler: military costs. Indeed, in his fascinating The Rise and Fall of Great Powers, Prof. Kennedy notes on page xvi that "The history of the rise and later fall of the leading countries in the Great Power system...shows a very significant correlation over the longer term between productive and revenue-raising capacities...and military strength on the other." Here is how wealth and military power are linked symbiotically: "It sounds crudely mercantilistic to express it this way, but wealth is usually needed to underpin military power, and military power is usually needed to acquire and protect wealth." So why do Empires run out of money? Kennedy notes that "If, however, too large a portion of the estate's resources is diverted from wealth creation and allocated instead to military purposes, then that is likely to lead to a weakening of national power over the longer term." Step in America (where I lived, in Oregon), for 14 years!

I suspect that Brazilian supermodel Gisele Bundchen may not have read Kennedy, Gibbons, Huntington or Spengler before or even after instructing her finance guy that in future, she refuses to be paid in US dollars. She signed a contract with Procter & Gamble this August to represent their Pantene hair products - and insisted on payment in Euros. And last month she struck a deal to promote Dolce & Gabanna's new fragrance, "The One", and again insisted on payment in Euros...

Perhaps some miles from the catwalk, PIMCO's CIO, Bill Gross, is quoted as saying that "...if you had only one idea, one investment, it would be to buy an investment in a non-dollar currency."

Do these two people know each other?

2. Oil and gold

Important trivia: gold set a lifetime high of US$850/barrel in January 1980; on Tuesday, 6th November 2007, it reached US$821...

We all have our reasons why these two commodities are rising. My guesses include but are not limited to the following:

• Hedging against the dollar demise - i.e. invest dollars in things that are going up, knowing for sure that "things" and thus interest rates will keep heading south in the United States. Indeed, on Monday, the dollar fell to a record low of $1.46/euro since the Euro was launched in 1999!;
• Further military messes in the Muddle East (no typo!). I am thinking about Mr. Bush angering the Turks re. the Kurds, who are American allies in Iraq. And I would not put it past Bush to attack Iran, sadly. So up goes the price of energy and fear (oil and gold, of course).
• Commodities. When commodity prices rise, extra cash is created. That excess supply of money has to go into some asset. If oil and gold are the flavours of the month, the very rises in their prices begets more money going into these very commodities!

3. How to Make Money Off This Idea

1. Always talk with your financial adviser first!
2. Go long non-dollars, e.g. high - yielders  like Sterling and the Euro, commodity-backed currencies like the Canadian and Australian dollar and the NZ dollar, and the yen, which will rise modestly once gaijin carry trades are unwound. But don't get too carried-away: it is probably the ever-sharp Japanese Hausfrau who is doing lots of carry trades, and she won't give up on gaijin markets, given that her domestic returns are paltry on a good day...
3. Buy gold miners in America and China. According to that fountain of wisdom, the South China Morning Post of 7th November 2007, South Africa is king. Amazingly, however, China is nipping South Africa's as well as America's heels and could well become the world's second largest gold producer this year. Currently, the United States is the world's second largest producer of gold - but China may change this. There are at least two quoted Chinese gold mining companies: Hong Kong - listed Zijin Mining (2899:HK), which runs China's biggest gold mine; its shares have more than tripled over the past year, and Sino Gold Mining (SGX:AU), which is China's second largest gold mining company and is listed in Sydney, Australia. Meanwhile, in the same rag, India is the world's largest gold consumer, so why not hunt for a good, quoted Indian jewelry company?
4. When oil rises, so does gold. My hunch is that the rich folk producing the oil (and other commodities) have gold as a fixed percentage of their portfolios, so higher oil prices beget more gold purchases.
5. When the dollar falls, gold gets cheaper for non-dollar-based investors.So:what are all of those rich folk in the commodity-producing countries doing with their monies? One cheap "in" to gold is an attractive gold ETF.
6. Get an oil ETF. Oil prices are subject to lots of seasonal influences. In winter, the Northern Hemisphere gets chilly - so up goes oil demand. Simple. Of greater concern is American policy in the Muddle East, however: if they were stupid enough to invade Iraq, why not Iran, too? What does Bush Jr. have to lose?
7. Who will design and build the oil pipeline from Russia to China? PM Wen Jiabao currently is vising chilly Moscow. Amazingly, China gets all of her oil supplies from Russia (who owns the world's eighth-largest known oil reserves) via state-owned Russian Railways (RR). Apparently, Moscow makes RR charge rail tariffs, so that dents the profits of Russian oil producer Rosneft who, in effect, has to "pay" these tariffs by conceding lower oil prices to the Chinese.