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Currency Wars?


Viking
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How are people on the board thinking about recent currency movements? Before last year I had never really thought about currency when making an investment decision. The last year the U.S.$ has been on a tear and it looks set to continue. Over the past 24 months there have been massive moves in the currency markets as countries attempt to generate growth:

1.) Japan massively weakens the Yen; exports increase significantly

2.) ECB, partly in response to Japan, needs growth and is weakening the Euro; we may see parity this year to the US$

3.) Russian ruble has depreciated massively

4.) commodity currencies (Can$, Aus $, Kiwi) have depreciated 25% in last 24 months vs US$

5.) Swiss franc is the outlier; by removing the peg to the Euro the currency is appreciating

6.) the big 'winner' is the US$, which is appreciating massively. How long can this continue before the U.S. says enough is enough?

7.) China's currency is pegged to the US$; as the US$ shoots to the moon China exports become less competitive.

 

Many developing countries hold their national debt in US$. Their 'earnings' are falling as economic growth slows and the home currency falls; debt payments in US$ become harder to make. This is what caused all currency crises in developing nations in the '90's. Looks like the same movie is playing again!

 

Global growth is slowing. China is slowing. Euro region is slowing. Commodity exporting countries are slowing. The U.S. is the one area where the domestic economy looks to finally be growing (at a slow pace). However, if the U.S.$ continue to appreciate against world currencies at what point does the US$ economy get hit and US politicians react? And if the U.S. economy starts to slow then we likely enter a new phase in the current game.

 

If the global economy enters a recession later this year what will the central bankers do to stimulate growth? Drop interest rates the usual 2 or 3 % to get the economy moving? Nope; bank rates are already under 1% so they is not much room to go lower. How about talking the currency down to drive exports? Nope; already tried that too. Bottom line is if we enter a global recession in the next 12 months we are in uncharted territory.

 

The appreciation of the US$ is already hitting large US multinationals; during current earnings season as many are missing earnings and providing weak guidance due to crazy strong US$.

 

I have done my best the past 2 years to not think about macro when investing. However, I am getting increasingly nervous about how all of this is going to play out. Looks to me like there is more uncertainty right now than usual. This tells me that volatility will likely rule. Expect the unexpected.

 

From an investing standpoint, I am going to be more conservative than usual. Hold more cash (US$). Be patient. If volatility returns, we should get some great opportunities once again to buy great businesses at cheap prices. I think I might do a little reading and dust off some of the books I bought back in 2008 and 2009 on what has happened in past debt/deflationary periods (focussing on round 2 shocks that hit 4-5 years after the initial crisis).

 

http://www.bloombergview.com/articles/2015-01-23/europe-just-started-waging-currency-war-on-the-u-s-

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From an investing standpoint, I am going to be more conservative than usual. Hold more cash (US$). Be patient. If volatility returns, we should get some great opportunities once again to buy great businesses at cheap prices. I think I might do a little reading and dust off some of the books I bought back in 2008 and 2009 on what has happened in past debt/deflationary periods (focussing on round 2 shocks that hit 4-5 years after the initial crisis).

 

Like you, I plan primarily to read and learn.  I've had James Grant's Money of the Mind and Minding Mr. Market on my pile of books to read for years (?decades).  I'll start on them soon.

 

On the investment side, I'll resist buying gold.  Possibly a mistake.  How do you think about gold?

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If you look at the Great Depression where there was a series of devaluations, each successive market that went off the gold standard (the "rock") rallied.  UK first, then the US then Europe.  You are seeing that now with Japan now Europe.  At some point the US will do its own QE4 to reduce the $ strength.  The key in each of these situations is to hold real assets (stocks and real estate) as they will not decline in value as the currencies are depreciated to monetize the debts.  Leverage also helps as it is denominated in depreciated currency.

 

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http://www.telegraph.co.uk/finance/mark-carney/11367570/Mark-Carney-warns-of-liquidity-storm-as-global-currency-system-turns-upside-down.html

 

Global watchdogs say the scale is so large -- and subject to "clustering" and crowd psychology - that these funds may all rush for the exits at the same time in a crisis and amplify the effects.

 

The concerns were echoed by Benoît Cœuré, a board member of the European Central Bank.

 

"The system is untested. We had a wave of new financial regulation, which has mostly focussed on banks, so we're pretty sure that banks are much safer," he said.

 

Mr Cœuré said the ECB was forced to throw caution to the winds and launch a €60bn blitz of bond purchases on Thursday, given that inflation expectations in the eurozone have collapsed, with outright deflation in December.

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This is my take (to a significant degree influenced by Ray Dalio's views):

 

Given interest rates are being manipulated by central banks across the curve in most countries - and basically at zero across the curve except in North America, the global adjustment at this point will be the currencies - and we are seeing that already play out. Over the past 12.5 months, the $US has been strong relative to almost all currencies - and North American yields could further the adjustment by decreasing this year. Once this yield reduction and the run in the $US ends (where that dollar run may have imported deflationary/recessionary forces into the US) - and say we hit a recession in the US in the next year or two (yes, recessions do happen in the US even with Fed around), and this is likely to happen when financial assets (eg, stocks, corporate bonds, etc) are at very high levels - there is no ammo left at that point for the Fed (in terms of lowering interest rates anywhere on the curve), and deflation or stagflation may set in across developed countries. This will be the first time in 40 years when the Fed can't lower rates in a recession. At that point, there is no adjustment globally (interest rates can't adjust, currencies in a circular spiral going down the drain).

 

1. If stagflation sets in, given current central bank policies, gold will do very well.

 

2. If instead deflation sets in, our God-like central bankers will jointly print so much money we might as well just call it a new monetary system. If this happens, gold will also do very well. Now this is counter-intuitive as deflation is usually bad for gold. With these global policy-makers in place, I think deflation portends significantly more monetary debasement which is, albeit counter-intuitively, positive for gold. We see this already over the past 12.5 months. Gold has risen in value against all main global currencies (its done better than even the $US).

 

3. If by some miracle the US pulls itself out of this upcoming recession (say one that starts in 1 to 3 years) while financial assets are falling - along with pulling the entire developed world along to higher growth - at a time the entire developed world is also over-indebted, well gold will not do as well. (I am not betting on this).

 

I think the best store of value is gold (I prefer silver and precious metal miners as they have more upside potential). If you want to take more risk, then equities, real-estate, etc. But if you want to be more conservative at this point, and go to some "cash" because you see equities as highly valued, I suggest that - given the constant debasement of the currencies - having at least 10% of that cash in precious metals related investments makes a lot of sense. (I personally have much more than this percentage but I would not advocate that for other people's portfolios)

 

Its crazy not to have 10% of cash in precious metals. If the choice is $US or gold, I'll take gold hands down (at least in terms of my cash equivalents). My view is that gold has been suppressed for some time now and that is ending or near the end. As it starts to move up, it may really accelerate. At the same time the supposed omnipotence of our God-like central bankers will decline dramatically. The point I make in #2 above - that deflation portends significantly more monetary debasement and thus is positive (not negative) for gold - is the critical one. If you agree with that, then gold makes a lot of sense right here. If you don't, then probably not as much.

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How are people on the board thinking about recent currency movements? Before last year I had never really thought about currency when making an investment decision. The last year the U.S.$ has been on a tear and it looks set to continue. Over the past 24 months there have been massive moves in the currency markets as countries attempt to generate growth:

1.) Japan massively weakens the Yen; exports increase significantly

2.) ECB, partly in response to Japan, needs growth and is weakening the Euro; we may see parity this year to the US$

3.) Russian ruble has depreciated massively

4.) commodity currencies (Can$, Aus $, Kiwi) have depreciated 25% in last 24 months vs US$

5.) Swiss franc is the outlier; by removing the peg to the Euro the currency is appreciating

6.) the big 'winner' is the US$, which is appreciating massively. How long can this continue before the U.S. says enough is enough?

7.) China's currency is pegged to the US$; as the US$ shoots to the moon China exports become less competitive.

 

Many developing countries hold their national debt in US$. Their 'earnings' are falling as economic growth slows and the home currency falls; debt payments in US$ become harder to make. This is what caused all currency crises in developing nations in the '90's. Looks like the same movie is playing again!

 

Global growth is slowing. China is slowing. Euro region is slowing. Commodity exporting countries are slowing. The U.S. is the one area where the domestic economy looks to finally be growing (at a slow pace). However, if the U.S.$ continue to appreciate against world currencies at what point does the US$ economy get hit and US politicians react? And if the U.S. economy starts to slow then we likely enter a new phase in the current game.

 

If the global economy enters a recession later this year what will the central bankers do to stimulate growth? Drop interest rates the usual 2 or 3 % to get the economy moving? Nope; bank rates are already under 1% so they is not much room to go lower. How about talking the currency down to drive exports? Nope; already tried that too. Bottom line is if we enter a global recession in the next 12 months we are in uncharted territory.

 

The appreciation of the US$ is already hitting large US multinationals; during current earnings season as many are missing earnings and providing weak guidance due to crazy strong US$.

 

I have done my best the past 2 years to not think about macro when investing. However, I am getting increasingly nervous about how all of this is going to play out. Looks to me like there is more uncertainty right now than usual. This tells me that volatility will likely rule. Expect the unexpected.

 

From an investing standpoint, I am going to be more conservative than usual. Hold more cash (US$). Be patient. If volatility returns, we should get some great opportunities once again to buy great businesses at cheap prices. I think I might do a little reading and dust off some of the books I bought back in 2008 and 2009 on what has happened in past debt/deflationary periods (focussing on round 2 shocks that hit 4-5 years after the initial crisis).

 

http://www.bloombergview.com/articles/2015-01-23/europe-just-started-waging-currency-war-on-the-u-s-

 

Viking, its good you are thinking about currencies because there is a big risk they continue to be a huge force in the coming 6-18 months. If other Buffett followers want to stick their heads in the sand and "ignore the macro", they may very well get a lot of surprises in the following year or two. 

 

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I don't think Buffet is sticking his head in the sand about the macro or gold as an alternative investment issue.  He clearly lays out his case for gold as a commodity whose quantity is constantly increasing and provides no return other than what others are willing to pay and compares gold to the other productive assets (real estate and stocks) could buy with it value at current prices.  BTW Klarman is also of this opinion.  Also if you look at stock prices in the Great Depression many firms increased in value in real terms by the end of 1933.  These include consumer products companies (like Coca Cola and Firestone Rubber), chemical companies (duPont and Monsanto), can companies, tobacco companies and some mining companies (gold and nickle).  I would rather hold a mix of good businesses then a commodity whose quantity is only increasing or cash in debased currency.

 

I don't see how stagflation is even going to start.  The last time this happened was when there was wage inflation in the 1970's.  That is not close to happening today and increased productivity every year is keeping wage inflation in check.  Historically, wage inflation has been caused by worker shortages caused by war, famine or disease.  None of these three has been present on a mass scale since the mid 1900's. 

 

Deflation tools are numerous beyond zero interest rates.  For example, the treasury could send everyone in the US a check in the mail refunding their taxes and use printed Fed money to pay its bills until inflation arrives.  Which asset do you think will retain its value under this scenario?  Real productive assets like stocks will.  Gold may have a spike but over time its has declined in real terms.

 

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Good points.

 

Howard Marks also says that he cannot value assets without cash flows, such as gold and oil.

 

Eveillard at First Eagle and the folks at International Value Advisers like some gold (5-10%) as a (hyper)inflation hedge.

 

There is some research saying that Equities in Zimbabwe and Weimar Germany kept (almost) up with Hyperinflation.

 

As a form of currency, gold is certainly valuable.

 

;)

 

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For businesses doing well during deflation you can look at companies such as Toyota in Japan over the last 25 years. There are several such examples.

 

A good business will adapt to the new reality better than most other investments that one can think of.

 

Bonds or income generating securities that can survive and maintain their payments during the deflationary period. 

 

I believe the reserve currency of the world is a good place to be, comes from the 1930s experience. UK and GBP did better than others. Back then GBP was the reserve currency as most commodities, global trade and debt ends up being in that currency.

 

Avoiding debt will make a huge difference. I still recall from a link someone had poster here back in 2010 or so. It was a Fairfax employee newsletter. In that letter, Watsa had come out and said he recommended to employees that they have no debt - not even an auto loan for this very reason, if I recall correctly.

 

I would want gold only if civilization was falling apart and I don't see that happening anytime soon.

 

I am fascinated by India as an opportunity (opposite of the developed world - young and low levels of debt)

- India should benefit due to commodity deflation - it is a net importer of energy/commodities.

- I believe less than 10% of Indians have a mortgage and there is a huge shortfall in housing stock.

- 50% of the population is under 28 (they will start earning and consuming over the next 20 odd years).

- Large amount of infrastructure needs to be built.

- it is an economy that is not that integrated into the global economy.

- Investment cycle has just started in India (they just have to educate people, build infrastructure) and they will have enough growth just because of internal demand.

- Lots of barriers to doing business (removal of these barriers will speed up growth)

 

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GDP growth in india has been flat though. And corruption is a huge problem, it does not seem to be a very business friendly place. Allthough that can have its advantages too I guess.

 

Why not Africa? A lot of countries there grow at double digit rates, low debt/gdp, and some of them have a better business climate then Italy even. And there is a shortage of capital there (so better asset prices).

 

Im more of a follower though, so ill wait untill i see some good ideas being posted in Africa, and then follow along :) . One idea I like is Conduril. Does a lot of construction in Africa and is likely to grow, and is cheap. Plus it is on a european stock exchange, so you would expect less corruption and fuckery.

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If you want to read about how assets performed in other deleveragings Ray Dalio's website (and Bridgewater's excellent research paper there) would be my first point of reference.

 

I'd be very careful with James Grant's opinions, though. They are interesting and unconventional but they are also quite quirky, to say the least. Dalio's ideas aren't mainstream either but he has been testing them intensely – not in phantasy land but in the markets – and they've been proving their value so far.

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I don't think Buffet is sticking his head in the sand about the macro or gold as an alternative investment issue.  He clearly lays out his case for gold as a commodity whose quantity is constantly increasing and provides no return other than what others are willing to pay and compares gold to the other productive assets (real estate and stocks) could buy with it value at current prices.  BTW Klarman is also of this opinion.  Also if you look at stock prices in the Great Depression many firms increased in value in real terms by the end of 1933.  These include consumer products companies (like Coca Cola and Firestone Rubber), chemical companies (duPont and Monsanto), can companies, tobacco companies and some mining companies (gold and nickle).  I would rather hold a mix of good businesses then a commodity whose quantity is only increasing or cash in debased currency.

 

I don't see how stagflation is even going to start.  The last time this happened was when there was wage inflation in the 1970's.  That is not close to happening today and increased productivity every year is keeping wage inflation in check.  Historically, wage inflation has been caused by worker shortages caused by war, famine or disease.  None of these three has been present on a mass scale since the mid 1900's. 

 

Deflation tools are numerous beyond zero interest rates.  For example, the treasury could send everyone in the US a check in the mail refunding their taxes and use printed Fed money to pay its bills until inflation arrives.  Which asset do you think will retain its value under this scenario?  Real productive assets like stocks will.  Gold may have a spike but over time its has declined in real terms.

 

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So I think if you look out very very long-term like Buffett, a great stock will do better than gold. Just like a great stock will do better than ANY currency over 30, 50 or 100 years. I am not sure, however, that in the next 5-7 years or so the average US equity - already at fairly high valuations - will outperform gold (a store of value which tends to keep its real value unlike a currency that is printed).

 

A great company at a great price will outperform gold even over the next 5-7 years - there is no question. What I am saying is that your neutral position should no longer be 100% cash (if indeed that was your neutral position say 5-10 years ago), it should now be less than 90% cash and more than 10% precious metals - as a hedge against monetary debasement.

 

 

 

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I agree that the large averages may be at modestly high levels but typical CoBF folks do not buy the averages.  There are a number of areas of modestly priced/distressed areas of the market to chose from today including: autos and related components, oil and gas, gaming, leasing and telcos.  From my view we are not at nosebleed levels like 1999 or 2007 yet.

 

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Just theoretically speaking, what would you do assuming most markets do reach 2007 levels? Would you hold cash or some sort of alternative currency or just buy the cheapest stocks in an expensive market?

 

Valuations, at least on a median basis, are materially higher than 07.

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Using median and means of markets I think is the issue.  If these metrics were used, you would miss out on material appreciation from mispriced securities.  Also, I do not think there is a strategy using these metrics to get in and out of stocks that can out perform an stock index.

 

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On gold I see its purpose as being a common denominator to money.  The value in it is that you can take anything and convert it into gold and then convert the gold into something else.

 

The value it has is its convertibility.  I'd put out there that at some points investors highly value that and the price rises, and other times they don't and it falls.

 

But speaking of gold, I have some non-financial friends who are starting to really talk about it.  These aren't fringe-wacky types either.  Not sure what it means, just a point of reference.

 

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Using median and means of markets I think is the issue.  If these metrics were used, you would miss out on material appreciation from mispriced securities.  Also, I do not think there is a strategy using these metrics to get in and out of stocks that can out perform an stock index.

 

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Always a fair point. For me, it's the hardest time in my career finding appealing investments.

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GDP growth in india has been flat though. And corruption is a huge problem, it does not seem to be a very business friendly place. Allthough that can have its advantages too I guess.

 

Why not Africa? A lot of countries there grow at double digit rates, low debt/gdp, and some of them have a better business climate then Italy even. And there is a shortage of capital there (so better asset prices).

 

Im more of a follower though, so ill wait untill i see some good ideas being posted in Africa, and then follow along :) . One idea I like is Conduril. Does a lot of construction in Africa and is likely to grow, and is cheap. Plus it is on a european stock exchange, so you would expect less corruption and fuckery.

 

I think corruption is a big problem in Africa too. As a bonus you get random warlords and refugees. Infrastructure may be worse than in India.  Anyway, Africa is a pretty big place, so I'm sure some countries there have a good business climate and good growth.

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