and Non-US$ Commodity Prices
March 2, 2004
Below are extracts from recent commentaries
posted at www.speculative-investor.com
fundamentals for the US$ are very bearish and boil down to the
a) The US runs
a massive current account deficit.
b) Due to high
debt levels throughout the US economy and a stock market that
is priced for perfection, future real returns on investment will
be sub-par and the US will therefore be unable to attract enough
new foreign investment to offset the current account deficit.
The combination of a) and b) above all but guarantee that the
dollar's long-term trend will remain down until the current account
deficit has been eliminated or until the prices of dollar-denominated
investments become low by historical valuation standards.
It is always, however, possible for any market to move counter
to its long-term fundamentals for an extended period (one year
or even longer). Therefore, market participants should not rule-out
the possibility that the dollar will embark on a substantial
rebound at some point over the next few months.
Something that has the potential to cause a change in the dollar's
intermediate-term trend is a change in the spread between the
short-term US$ interest rate and the short-term euro interest
rate, either as a result of the Fed hiking rates or the ECB lowering
rates. This is because a change in the interest-rate spread,
or even the anticipation of a change in the interest-rate spread,
would prompt large players in the currency and debt markets to
begin unwinding their dollar-carry trades. (An example of a dollar
carry trade is borrowing dollars then exchanging the dollars
for euros and investing the proceeds in higher-yielding euro-denominated
debt; the result being a short-dollar/long-euro position that
benefits from the relatively higher euro interest rate and the
upward trend in EUR/USD).
The thing with carry trades is that they are self-reinforcing
in one direction while they are being 'put on' and then self-reinforcing
in the opposite direction while they are being closed out. In
the case of the dollar-euro carry trade, for example, large bets
have been made based on an expectation that the US$ interest
rate will remain below the euro interest rate and that the US$
will continue to weaken relative to the euro; and these bets
have, in turn, caused the US$ to become weaker than it would
otherwise have been. However, if expectations change and these
trades start being unwound there will be considerable upward
pressure on the US$.
Two things that US$ bears continue to have in their favour, though,
are that the US Administration does not want the dollar to strengthen
prior to the November-2004 elections and the Fed will almost
certainly not hike US interest rates until it is forced to do
so by the bond market. The US Administration probably won't get
its wish (the dollar will probably be above its current level
by the time the elections roll around), but the Fed's first rate
hike is being pushed out in time by the upward drift in the bond
market. Furthermore, the ECB would be unlikely to lower euro
interest rates unless the euro moved to new highs because doing
so would risk creating a bigger inflation problem in Europe.
In terms of
the euro and other relatively strong currencies commodity prices
have been a lot more docile, over the past few years, than they
have been in US$ terms. Or, to put it another way, a lot of the
strength we have recently seen in the CRB Index has been a result
of US$ weakness as opposed to 'real' strength in commodities.
This is not something that has escaped our attention and neither
has it been a surprise to us since anticipated US$ weakness was
one of the main reasons we went on record, during the dark days
of Q4 2001, as saying that commodity prices were about to embark
on a large multi-year rally.
The response of the commodity markets to a weakening US$ over
the past two years is not materially different from what happened
during the 1970s. In fact, we can't think of a reason why there
would ever be a huge, broad-based, multi-year rally in commodity
prices if not for inflation and its effects on the relative values
of the fiat currencies. For instance, if the US$ were as good
as gold then the long-term chart of the CRB Index would, we think,
approximate a horizontal line with a few minor oscillations.
As an aside, a chart of the CRB/gold ratio covering the past
30 years does not approximate a horizontal line; but that's because
the price of gold, under the current monetary system, tends to
experience disproportionately large swings in both directions
in response to changes in confidence.
Further to the above, if it is reasonable to assume that the
US$ is in a long-term bear market then it is equally reasonable
to assume that US$-denominated commodity prices are immersed
in a long-term bull market. Also, taking note of how US$ inflation
has affected US$ commodity prices it is reasonable to assume
that commodity prices are eventually going to move much higher
against all the currencies that have been, and continue to be,
inflated at rapid rates. In other words, against all the major
fiat currencies since they are all experiencing rampant inflation.
After all and as explained at TSI many times over the past 3
years, when the supply of money increases at a rapid rate over
an extended period it is axiomatic that prices will rise somewhere
in the economy. The only thing we need concern ourselves with
is which prices.
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