Macro Tides – “USD: Inflation and then Deflation”
Dollar Fundamentals
The January Marco Tides was entitled “Will the Consensus Be Right in 2021?” and one of the consensus trades highlighted was the almost universal view that the Dollar would continue to fall. This view was shaped by the Dollar’s -12.7% decline throughout 2020 after peaking on March 23 at 102.99 and closing at 89.94 on December 31. The fundamentals most often cited by Dollar bears is the federal budget deficit and trade deficit which increase the amount of Dollars flowing overseas and in the U.S. as measured by M2 money supply. The logic is straightforward – more US Dollar supply will exceed demand and result in a lower Dollar. The huge budget deficits in the wake of the financial crisis lifted Federal Debt as a percent of GDP from 62% in 2007 to 100% in 2013. The COVID- 19 pandemic has caused the Debt to GDP ratio from 102% to 137% in less than a year compared to the six years it took after the financial crisis for a similar increase.
Dollar Perma Bears
The rapidly of the increase in the federal budget deficit in 2020 and persistent rise in the Debt to GDP ratio since 1981 when it was just 31% has spawned a cadre of vocal Dollar bears that always tout ‘The sky is falling’ perspective. One of the most vocal is Peter ‘Shrill’ Schiff of Euro Pacific Capital, who has been warning of the Dollar’s demise for a long time and who is always a big proponent of Gold.
| September 25, 2009 – Peter Schiff: U.S. Stock Rally and Dollar Doomed, Gold Going To $5,000 |
The worst is not over, according to Euro Pacific Capital‘s Schiff, who predicts the Dow will fall another 90% from current levels when measured against gold. A longtime dollar bear and gold bull, he foresees gold hitting $5000 per ounce “in the next couple of years,” and predicts the Dow and gold will trade on a one-to-one ratio vs. the current level of around 9.7-to-1. Schiff’s forecast is based on his view the U.S. dollar is going to collapse under the weight of our massive deficit and reckless policies of the Obama administration, which he compares to the massive spending programs of the 1960s, which paved the way for gold’s ascent in the 1970s. |
(The actual low was 7449 in March 2009 six months before this interview. If the Dow had fallen another 90% from its September 25, 2009 close of 9,665 it would have subsequently fallen to 966. Gold traded up from $1000 in September 2009 to $1920 in September 2011 before falling to $1046 in December 2015)
May 2013 – Dollar Bears Aren’t Wrong … Just Early
“The dollar is going to collapse if [Fed Chairman] Ben Bernanke doesn’t reverse course,” Schiff said in an interview with Yahoo! Finance. “And if he does, the whole phony economy that has been built on the foundation of stimulus is going to collapse as well.” (In May 2013 the Dollar was trading around 83.00 and subsequently rallied to 103.82 in January 2017, an increase of 25%. The Fed began to increase rates in December 2015 and the economy continued to hum along until the Pandemic hit in early 2020 after recording the longest business expansion in U.S. history.)
July 30, 2020 – The Dollar is not just going down, it’s going to crash
The following is from an interview with Liz Claman from Fox Business news. “I think the dollar is going to keep drifting down until it collapses. And this is going to usher in a real economic crisis in America, unlike something we’ve ever seen. Because it’s going to force the Fed to choose between saving the dollar, and dumping all the bonds it’s been buying, letting interest rates rise sharply, forcing the US government to slash spending right now and abandon all these stimulus plans, or just let inflation ravage the entire economy and wipe out a generation of Americans.” Liz Claman asked Peter what is the trade given what’s coming down the pike. “Get out of dollars. Number one, yeah, own gold and silver. The gold and silver mining stocks are killing it, but they’re just getting started. I mean, these stocks, I think, can go up 10, 20 times in dollar terms.” (Since July 30, 2020 and through January 28, 2021, the Dollar is down -2.5%, Gold is off -5.7%, Silver is up +8.2%, but Gold stocks as measured by GDX have been slammed by -19.5%.) https://schiffgold.com/interviews/peter-schiff-the-dollar-is-not-just-going-down-its-going-to- crash/
January 29, 2021 – Silver Surges as GameStop Day Traders Move Into Other Assets
Some notable precious-metals bulls were taking notice of the big swings. Peter Schiff, CEO of Euro Pacific Capital, said on Twitter that the move into silver shows that the Reddit day traders are getting smarter because silver miners have good value. “Silver stocks are actually cheap, and represent good investment value,” he said. (Reddit traders will be heartened by Mr. Schiff’s assessment of their improving investment prowess.)
The quality of the investment advice Mr. Schiff has provided for more than a decade speaks for itself. It is remarkable that Mr. Schiff is still sought out as a speaker and ‘expert’ at investment conferences and in the media. Clearly there is a demand from those who find dire warnings of impending doom attractive. Mr. Schiff uses scary outrageous headlines to garner attention (and others like him) and I would suggest taking any extreme warning published by anyone with a grain of salt, since the primary goal is to grab your attention rather than providing insightful analysis. Mr. Schiff’s forecasts are based on an overly simplistic investment thesis that has a ring of fundamental logic, which makes it easy for the unsophisticated to latch onto. Large budget deficits and trade deficits are unhealthy, but that won’t necessarily keep global investors from buying the Dollar or Treasury bonds in an uncertain world. The Federal Reserve dramatically expanding its balance sheet may end badly, but in the short run it has forestalled a deeper and longer lasting economic contractions after the financial crisis and COVID-19 Pandemic that would have inflicted far greater economic suffering on those who can least afford it.
Gold is often pitched as the best investment to own during a crisis which is why investors are often urged to maintain at least a 5% allocation to Gold as insurance. In May 2008, and just a few months before the financial crisis, Gold traded up to $1014. When the crisis erupted in October 2008, Gold traded down to $681 more than 30% below its May 2008 level. (See chart on Page 3.) As the COVID-29 Pandemic unfolded, Gold rose to $1686 in February 2020 before falling to $1452 in March a decline of -13.8%. In fairness it can be argued that Gold eventually rallied to higher prices after each crisis had passed, but it is ironic that during each crisis it declined. Gold is an asset and during a liquidity crisis that causes stocks, bonds, or other assets to lose value quickly, investors are often forced to sell assets including Gold to meet margin calls, and during the last two crisis’ that’s what occurred.
Is a Dollar Crash Coming Soon?
The biggest risk in coming years is the status of the Dollar as the world’s Reserve Currency. Although the Dollar’s share of global reserves has slipped from 70% in 2000 to 60% now, it remains the dominant currency by far for a number of good reasons. No other nation has a debt market that can match the depth and liquidity of the U.S. Treasury market and corporate bond market. In the foreign exchange market the Dollar is part of about 85% of all currency transactions, and more than 60 countries peg their currencies to the Dollar. All major commodities including oil, industrial metals, agricultural products, and Gold are priced in the Dollar. Although the Dollar’s role has diminished modestly in recent decades, the Dollar is clearly the dominant currency and that’s not likely to change much in the next 10 to 20 years.
If the Dollar is going to collapse from the dual weight of the budget and trade deficits, it will first break below important long term price support. A breakdown of meaningful support will provide us an early warning of much more trouble to come, which is why incorporating technical chart analysis must play a role in analyzing the Dollar’s future.
Observing the gradual change in the Dollar’s fundamentals is of value, but is unlikely to provide little guidance as to when the tipping point has been reached. This is where the combination of fundamental analysis and technical analysis can prove most helpful. Technical analysis can provide insight when the risk from fundamental factors like the budget and trade deficits are increasing to a dangerous level and often well before a ‘Dollar Crisis Shakes Global Financial Markets’ is the headline. The range of 87.50 and 88.50 on the Dollar index has been a critical pivot point since 2008. The Dollar rallied from a low of 70.00 in March 2008 to a high of 88.50 in November of 2008, which was tested again in March of 2009. The Dollar subsequently fell to 75.00 in December 2009, only to rally up to 88.70 in June 2010. By May 2011 the Dollar had fallen all the way back to 72.70. The Dollar index broke decisively above 88.50 in December 2014 and by March 2015 traded up to 100.39. After peaking in January 2017 at 103.82 the Dollar fell for 13 months before bottoming at 88.25 in February 2018.
This chart analysis indicates that any decline below 88.00 in coming months will open the door for a decline to at least 75.00 and potentially 70.00 – 72.00 in the Dollar index. The key takeaway is that the Dollar will fall below 88.00 well before a ‘Dollar Crisis’ makes headlines. This makes the integration of technical analysis with the Dollar’s fundamentals indispensible.
Sentiment and positioning can provide valuable insight as to whether an important support level is more likely to hold or not. Foreign currency traders have become increasingly negative toward the Dollar as it has declines since peaking in March 2020, and have taken positions to benefit from a continued decline. Some of the price weakness in the Dollar has come from foreign currency traders from either shorting the Dollar or from buying other currencies with the expectation they will rise relative to the Dollar. The short position against the Dollar is approaching levels last seen in late 2017 and the first quarter of 2018 when the Dollar bottomed at 88.25. The extreme in negative sentiment and positioning increases the likelihood that the Dollar will not break below this important support and will instead rally. Given this analysis it is irresponsible to proclaim that the Dollar is about to collapse, until the Dollar falls below 88.00 at a minimum.
Jim Welsh
JWelsh@SmartPortfolios.com
