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Death of the Dollar?Dave Forest
There were a lot of reports this week about the demise of the dollar. Is the end of the greenback truly at hand? Or are reports of the dollar's death greatly exaggerated? And what does this mean for commodities? This week we cast a critical eye on some of the recent action in currency markets. One of the major "strikes" against the dollar recently was a report that oil market players may secretly be making plans to dump the buck. [Editor's note: This editor wants to stress the word 'may.' The bolding is mine] Many investors believe that a shift away from the dollar is already underway in some of the world's markets. Causing the recent slump in the dollar's value against many of the world's major currencies. We'll look at whether traders are really getting out of the dollar. And examine some interesting reports from the world's biggest banks that suggest an alternative explanation for the slump in the dollar. The recent fall in the greenback may not be as fundamental as some observers believe. We'll also look at another controversial story in the natural resource sector: shale gas. At a major conference on the topic this week in Texas, attendees heard both sides of the coin. Some presenters suggested that shale plays like the recently-proven Marcellus of the northeastern U.S. will be the energy savior of America. Others told the conference that the potential for gas production from this formation has been blown out of proportion (no pun intended), with production rates and decline curves being overly-exaggerated to make the play appear more than it is. Undeterred by the controversy, the New York Times took the opportunity recently to declare that development of shale gas will soon be underway around the world, unlocking trillions of cubic feet of new gas supply. But is a shale gas boom really likely? We'll look at some hard facts about the contested Marcellus play and reveal just how difficult it is to make shale work. Anyone who believes shale gas is simply a matter of drilling a well and watching the MCFs come flowing in should have a look at these numbers. But first, let's jump in with a look at what a dollar is worth these days. The Dollar Sheds Weight Everyone in the commodities sector has suddenly become a currency trader. This week, investors in gold, oil, base metals and a host of other hard goods were all talking about the value of the dollar. Indeed, the recent action in the currency markets has been striking. Since the beginning of October, the dollar has been on a near-steady decline against most major currencies. This month, the dollar is down 2% against the euro, 5% against the Australian dollar, and 6% against the Canadian dollar. These are big moves for a currency. And the dollar's fall isn't just benefiting other countries' money. Commodities also got a lift from dollar weakness. As we've discussed before, many of the world's major commodity exchanges price their goods in U.S. dollars. If the value of the dollar falls, it makes it cheaper for holders of other currencies to buy on dollar-priced exchanges. They can swap their euros, yen or Aussie dollars for U.S. dollars, and buy more gold or oil than they could spending the same amount of their own currency back home. The dollar-related boost for commodity prices has been cause for celebration in a number of camps. Particularly amongst gold supporters. Many gold buyers have long believed that the dollar will eventually decline severely in value, a result of fast-paced expansion of the U.S. money supply. If more dollars are being created, they reason, the less a dollar should be worth. This "death of the dollar" argument gained some traction last week, when Britain's The Independent reported that leaders in the Middle East, China, Russia, Japan and France have been holding secret meetings on buying and selling oil in currencies other than the dollar. This raised concerns that the demand for dollars globally will fall. Speeding devaluation. Upon the news, the dollar ticked lower against most currencies around the world. Indeed, this month's dollar weakness seems to be confirming sentiment that the buck is headed for a "no-confidence vote" from trading nations worldwide. But is that what's really going on? Does the decline truly represent waning interest globally in using the greenback as the "weapon of choice" in settling international commerce? Not necessarily. One interesting aspect of the recent decline in the dollar is its timing. The fall coincided (almost to the day) with the start of the fourth quarter. A time when investment funds typically shuffle their holdings. Many funds take the opportunity at the outset of a quarter to sell some of their "in the money" positions in order to lock in these gains. This leaves these large investors with significant free cash. Which they then look to invest in new areas. And it appears that one of the most recent areas of interest for investors is the currency markets. Since the financial crisis broke last fall, there has been rapid growth in investment products allowing investors to place bets on global currencies. Simply put, given last year's turmoil, currencies are seen as being safer than other types of investments. If you buy shares in company, the firm could go bankrupt. Yields on government bonds can be (and are) manipulated by central banks around the world. Even commodities trading involves counterparty risk. If you buy a bar of gold but the seller goes bankrupt before it can deliver the goods, you lose even if you made the right investment call. But trading currencies avoids many of these risks. The market is big and liquid. Currencies seldom go bankrupt. And best of all, currencies are one of the few types of investment that have been largely uncorrelated to the rest of the financial world lately. During last fall's panic, stock markets, commodities and real estate all fell in value. But currencies like the U.S. dollar rose. Investors who believe there may be more problems ahead for the financial system can use currency trading to make bets with less fear of getting completely wiped out in the event of another crisis. Recognizing this, banks around the world have been rolling out currency trading products, allowing more investors to get in on the action. As one Citibank vice-president recently told, The Banker magazine, "FX [foreign exchange] is now being seen as an investable asset class in its own right, beyond its historical use as a pure portfolio hedge." The head of FX products for BNP Paribas Europe agrees, saying recently that "Investors have increasingly been looking for instruments which will give them exposure to FX as an asset class." Clearly there is a trend towards more trading of currencies. More trading means currency values globally will increasingly be affected by investor sentiment. And not surprisingly, prevailing sentiment is that the dollar is headed for a breakdown. Several banks have rushed to cash in on the current anti-dollar trend. RBS recently unveiled its "currency pyramid" product, which allows investors to easily short the dollar against a basket of global currencies. All of which raises the question, is the recent fall in the dollar due to businesses around the world moving away from the buck? Or simply due to investors guessing that this will be the case? The former would mean that dollar weakness is fundamental. The latter suggests that the fall in the dollar is speculative. And we all know that speculative bets can reverse themselves quickly if and when sentiment changes. More of Something Useless Even if we assume that the dollar's recent weakness is due to fundamentals, the effect of a weak dollar on commodities may be somewhat different than many investors are expecting. It is entirely possible that the world will move away from the dollar. The recent explosion in the U.S. monetary base doesn't inspire much confidence in the currency. Even the bond market showed signs of non-confidence in the dollar this week. Between October 7 and October 14, yields on the U.S. 30 year bond rose nearly 0.3%. The largest single-week increase since May. Rising yields mean that investors are selling off bonds. A vote of non-confidence in the U.S. government. But a weak dollar may not be the boon for commodities that many investors are expecting. It was almost comical last week to see oil investors celebrating the news about the petroleum market potentially moving away from dollars. Indeed, if oil was to be sold in other currencies, it would be a significant setback for the dollar. Demand for bucks would drop, likely depreciating the currency. And this would raise the dollar price of oil. So far, so good. But here's the problem. If the oil market moves away from using dollars, the U.S. dollar price of oil isn't going to matter anymore. No oil company is going to be receiving dollars for its crude. The NYMEX price could go to $1 billion per barrel, and it won't make one bit of difference to the bottom line of oil producers. Did anyone celebrate this week because oil hit $28,000 Zimbabwean dollars per barrel? No, because no one sells oil in Zim. If the currency becomes obsolete, so do commodities prices based upon it. Increasing commodities prices due to dollar weakness is a "paper game" only. Yes, anyone who owns a barrel of oil or a bar of gold will be able to get more dollars when they sell. But those dollars won't buy any more than they did a month, a year or a decade ago. Owning more of something that's worth less is a net wash out. And this will be exactly the position that producing companies will find themselves in following a dollar devaluation. Suppose the dollar falls 50% tomorrow against the world's major currencies. Sure, the price of gold might double to $2,000 per ounce. And gold producers' revenues will double in stride. But for mines in any country outside the U.S., costs will suddenly double too. An Australian mine pays its workers in Australian dollars. It will now take the company twice as many U.S. dollars to buy the Aussie dollars it needs to pay its staff. Likewise for any supplies purchased locally. Steel, fuel, even camp food will cost double. This will ultimately ensure that margins (which are really the important metric for a business) improve little. Mines in the U.S. might fair somewhat better. They would still be able to pay employees in dollars. Except that any goods America imports from other countries would now be twice as expensive. That means fuel (made from imported oil), steel (made from imported iron ore) and a lot of mining equipment. Even labor would likely get more expensive as workers, now facing increased costs of living, would demand higher wages. Admittedly, a dollar collapse would benefit commodities companies in the very short-term. If investors see oil suddenly jump to $300 per barrel, the knee-jerk reaction will be to buy shares of oil producers. But the world will very quickly realize that a weaker dollar does not mean higher profits for producing companies. Life will go on, largely unchanged. Except that we will put a different symbol in front of our price quotes. You can read the full report here. Oct 16, 2009 Copyright ©2009-2010 Resource Publishers Inc. Note: To subscribe to Pierce Points please click here: www.piercepoints.com Pierce Points
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