Monday, February 23, 2009

Should You Invest in USD or Gold? cont'd

There's really no way to predict how different currencies will act in this on going crisis, just as nobody could really see it coming or foresaw its magnitude (perhaps except Doctor Doom & the Black Swan). Therefore I can only list out the underlying forces at work. You are welcome to contribute what additional signs to watch out for.

(1) USD buying pressure to ease when de-leveraging is completed
This is easier said than observed. USD should drop when global de-leveraging is completed and most USD loans are reduced down to a safer level. But it's hard to say when. Even though most banks in US and Europe are re-capitalized and less leveraged, this is only relevant if value of assets they hold don't drop further. If we see higher grade debt instruments in US turn sour faster and deeper than expected, e.g. commercial real estate loans, credit card debt, municipal and state loan, etc, we know well this time it's not gonna be a localized problem in the US, as via securitization its effect will be broad reaching. And depending on whether the banks have learnt to hold more than enough USD for contingency, there's possibility for another USD rush when positions have to be closed. In addition, the on-going sell/scale down of foreign operations by US institutions will continue to support the USD as funds are repatriated back.

(2) USD borrowing to ease as interest rate is low everywhere
Companies are less likely to borrow in USD if they can get equally low rate in local currencies. In fact, a lot of existing USD debt will be refinanced with local currency debt. For example, in HK many companies are increasing their exposure to RMB debt to repay USD syndicated loan. This suggests lesser selling pressure for the USD. After witnessing the turmoil in the fx market last year, there aren't a lot of brave souls who would venture off-shore financing anytime soon.

(3) Spread of US treasury yield and corporate bond to narrow
It's happening and is a good sign that the bond market is breathing again, even only faintly. There are talks of quantitative easing everywhere, that the central banks will issue cheap debt and used the money to buy commercial loans/bond to push down the yield (i.e. borrowing cost). Whether that's gonna happen is not really important as investors have chosen to anticipate and act in advance, doing what the central banks want to do in advance and hoping to turn a quick buck when the central banks do move in. This seems neutral to the USD.

(4) US treasury buyer's stance, mostly Japan and China
Japan has no choice but to suppress the Yen, which is good for USD. Japan is an export economy and the US is its biggest customer. Its domestic market is too small to self sustain and it can no longer boast infrastructure spending. As most things Japan produces are human/physical capital intensive and it owns the brands, there's a lot of value adding so higher resources price in terms of a weaker yen is of lesser concern.

China on the other hand wouldn't mind a stronger RMB, for most of its exports are low value-adding and thus more sensitive to resources prices. A stronger RMB also brings cheaper imports (even for goods manufactured locally as resources are mostly imported) and boasts internal consumption, good prescription for the economy. However, China doesn't want to see a collapsed USD either as not only will the value of its USD assets largely deteriorate, Chinese suppliers will suffer badly too as they usually hold no brand, operating in fragmented industries, and have little bargaining power with US importers. A weaker USD will translate to lesser demand for goods and pressure for discount (i.e. Chinese side will need to absorb the loss from USD depreciation). If I were among the Chinese leaders I really wouldn't know which I prefer.

Another emerging trend is China is buying up natural resources everywhere in the world whenever opportunities arise. In time this may affect China's appetite for US treasury but at present there's not enough deals of magnitude big enough to cause such a swift. Moreover I note most deals, including the Russian oil deal and the Australian mine deal, are priced in USD (I suppose the reason being most commodities are priced and settled in USD), so China is only exchanging its USD reserve for something tangible, i.e. it doesn't involve buy/sell of new USD. And those selling countries/companies are in need of those USD to repay their USD debt as part of their de-leveraging. So this is really the other side of the same coin (i.e. factor (1)).

(5) Economic health of US and the others
This one is easier to spot - every economy is sick! And the common prescription is to borrow like crazy, either on the government level like in the US or much of Europe, or on business level via the easing of credit by banks like in China. If the borrowed amounts aren't enough to jump start the economies, there'll be a lot more money coming your way. In the end, it's the same for all currencies, i.e. a lot more money supply than before and nobody can be sure that the new money gets spent wisely. Therefore this factor is neutral as all currencies are not considered safe in this regard, i.e. low interest but no future.

But relatively, US is in a stronger position. If it is already hard enough for Obama to get things done quickly with just fellow democrats and the republicans, imagine how hard it is for Europe to agree on anything with all the different political ideologies. Moreover, the downfall of many smaller economies in Europe (including even Italy and Spain and of course the entire Eastern Europe) will drag down the Euro zone further. And the Russia position looks shaky and Europe as its neighbor is gonna feel the impact. If something drastic does happen in Russia, money will be flooding into the USD.

Summary
All the factors are mostly supportive of USD or neutral. The central theme seems to be if the US is bad, then everywhere else is just as bad and likely worse! Therefore I think the USD strength is logical and gonna sustain. WHEN and IF it does collapse, it won't be against other major currencies but rather against hard currencies, at present I think it's gold and oil (and there may be more). This is because the collapse is likely to be driven by the belief that most developed countries are close to bankrupt and thus paper currencies are no longer trusted. Monetary system takes a step backward and people will revert to holding hard currencies. So it's possible that a gold bubble is forming and maybe oil will follow steps too, and it doesn't require actual anticipated events to take place to support it, just imagination of it happening is enough to fuel it.

Comments:
I had expected HSBC to be stable when the rights were physically issued, and to decline afterward, since everybody that snapped up the HK$28 shares would dump them on the market asap.

However, after the rights window closed, the shares took off like a rocket. I find that a bit strange, like there was some manipulation.
 
i don't think it's new experience to you and me that prices do not follow one's expectation, especially over days or weeks. my goal when making each investment is only to try to guess it right over 6 MONTHS/YEARS.

why do you think there's manipulation when the share price is rising like a rocket, but not when it's falling like a stone? i think you have a general negative bias. but it may turn into an advantage if you make yourself aware of it.
 
Treasuries may be ok but I'd certainly encourage people to buy gold and hold.
 
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Of course in Gold...
 
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