US Dollar has enjoyed happy times for the most part of last century. In its full glory it was driven by bull market in equities from 1980, economy expansion and most importantly by its safe heaven appearance. After collapse of Soviet Union, nobody could challenge the USA super power and its world’s policemen status. Dollars were welcomed everywhere as official tender for transactions, and entire nations kept their wealth in
USD denominated assets. All black markets across the world and emerging economies had only one official currency – American Dollars.
Not any more. First dollars fall out of favor in shady circles: try to buy any real estate in Eastern Europe now: dollars are not welcomed. Now government institutions are ready to accept necessity of diversification out of reserve currency of choice. Dollar as any other FIAT currency is not backed by any tangible assets apart from “solid” government promise to pay back. This promise is based on government's ability to create wealth and spend less then its revenue in form of taxes and its ability to manage cash flow: its trade and current account. The US Dollar's fate is based on trust. Trust that government will repay the same value plus interest on its IOU, trust that government inflation figures are correct and you interest payment or yield on US Treasuries will be above real inflation and provide a positive return.
In August we have witnessed that the trust has gone, first in
subprime securities, then in rating agencies. All financial system was put on hold because nobody trusts anyone. The academic approach that derivatives are helping spread and reduce the risk have proved to be wrong. The risk was spread to the least prepared, those who trusted the AAA ratings of
subprime engineered junk. When even the risk averse sleeping state owned German banks get hurt in this turmoil, what is happening with risk proactive US banks?
Conservative Swiss
UBS was quick to shut down hedge fund with mere losses of few hundred million dollars and CEO gets fired within two weeks after that. In the USA, high profile victim so far is CEO of Standard and Poor’s rating agency, which were given high ratings to tranches of
CDO being paid by issuers of these junk paper. There will be more victims to come and losses will be exposed, but the first victim is already apparent. The US Dollar is losing its trust and appeal as reserve of last resort. The dollar is no longer preserving value, nor is it providing security as the most common investment instrument of US treasuries.
Dan Norcini reported: “This is the fourth consecutive week in which Treasury holdings by foreign Central Banks in the US Fed Custodial Accounts have fallen. I am continuing to monitor this development as it seems to be something flying under the radar screen of most analysts in spite of the ramifications involved should it continue and become a serious trend”
You can see the consequences of Stagflation and it's victim – US Dollar. After the
subprime shock and the housing melt down, the US economy, in real
inflation adjusted terms, will be in stagnation in the best case scenario. The government and Mr
Bernanke will try to fight this
subprime fire adding more gasoline. All these bubbles were created by easy credit and now they will try to save the financial system by pouring more money into it, creating monetary inflation and eroding value of
USD and other FIAT currencies. The l
ong term chart of 30-year US Treasury Yield is in its definite break out from multi year Down Trend after Double Bottom Reversal formation. The appetite for
subprime currency and assets denominated in it is falling and in order to sell it even AAA rated you need to raise the premium - yield. In addition, more selling of treasuries by China, Japan and other USA creditors will put more pressure on prices and yield will go higher with
USD going down.
Now this process will be accelerated with active role of Sovereign Wealth Funds (
SWF). In order to diversify their reserves from the US Dollar wealthiest countries have created
SWFs. According to
Financial Times, top ten have a 2.4 trillion dollars cash pile. With biggest
Abu Dhabi Investment Authority (
UAE) standing at 875 billion dollars. Also important to note that China allocated so far “only” 300 billion to its State Foreign Exchange
Inv Corp Central
Huijin. This comprises less then 25% of its more then 1.3 billion reserves. In the case of
UAE, it is 90% of reserves. Now all these money will be deployed in order to protect their value and secure resources for growth in all these countries.
As falling US
Dollar price continues, Gold and Silver will be going up driven by economic fundamentals of supply and demand. All raw materials will appreciate in their value. Demand created by rising population and infrastructure development in
BRICs countries will push commodities prices higher. Also, these countries are not experiencing any lack of paper dollars losing their value by the hour, further leading them in their willingness to exchange dollars for the real goods. As more paper money begins chasing the same supply of real goods, it will lead to the higher prices.
PGM and base metals industry will be driven by further consolidation. The trick is that you can not create any new
supply of commodities, gold or silver in a split second as you can create supply of new credit in the financial system. Mr
Bernanke does not even have to use helicopters for flush of liquidity rescuing markets, just political will and PC in Federal Reserve System. The new commodity
supply story is completely different – the cycle is long, boring and risky. You have to find deposit (it is rule of thumb that from 1000 drill holes only 10 will lead to economic discovery and only 4-5 will become mines). You have to secure all permits and financing. You have to build the mine with all necessary infrastructure: water, electricity, safety and environmental issues. You can allow from 6 to 10 years depending on type of commodity, technical issues and permitting process. After 20 years of bear market, the commodities industry is feeling the heat right now with lack of qualified personal, drills and diminishing resources base. Majors are not even exploring any more and are cultivating approach of partnership with Junior mining and exploration companies, spreading the risk and running short on time. Any economic deposit with proven time schedule to become a mine is under constant search in the industry.
Once we identified our major trend: the demise of US Dollar and the end of its status as reserve currency of choice, we can formulate investment approach. In order to put this into perspective just consider that all biggest gold mining companies comprising HUI
Amex Gold Bug Index have market cap of a little bit over 100 billion dollars now. Compare it to Google’s 161 billion dollars and the 2.4 trillion of Sovereign Wealth Funds seeking safety from collapsing US Dollar. Big names in the sector will benefit first: they are on the radar screens of investment banks fighting for the right to advise
SWFs.
Newmont Mining (
NEM) could benefit from consolidation by being number 2 in the sector with
Barrick Gold (
ABX) looking for new resources. Silver
Wheaton (
SLW) has unique business model of 100% silver revenue stream and fixed cost base, giving the exposure to option on rise in price of silver without time decay. Royal Gold (
RGLD) price action historically
preceds a move in gold price and it has recently developed buy signal. Tanzanian Royalty Exploration (
TRE) is backed by gold prophet Jim Sinclair and recently has entered into contract negotiations with a company from the People's Republic of China. Riskier plays which could bring more reward will be Mines Management (
MGN) with silver and copper deposit in Montana and Sterling Mines (
SRLM.OB) which is going to produce it's first silver from its Sunshine mine by the year end.
The sector is very volatile and provide one of the best entry point right now after recent sell off. You should stick with the best names in business who will not put their reputation on line for a quick buck. Among them is
Lundin Mining (
LMC), a diversified base metal producer with phenomenal growth. After recent acquisitions, the company with its commodity mix and strong financial position, becomes very attractive target itself and industry consolidation will drive the share price from recent lows. Voting in confidence of its rapidly expanding business
Lundin family trust bought 8 million shares in the company during the recent sell off and the share price is fighting its way back now.
The most impressive returns in this major investment trend of the decade will be made in junior mining and exploration companies. Money will infiltrate into this tiny sector from the industry majors rushing to secure promising projects for development of their resource base. Once the dust will settles and they will understand that demand is not affected by US stagnation or even recession and that financing is available, they will go shopping. The sector is very risky and demands a good industry network and discipline. But once you have found your best shots they will pay off handsomely. Investment approach, risk management and further research ideas can be found on my
website.
