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Tuesday, June 19, 2007
Back in December 2004, I nearly lost half my readers of True Wealth...
It was then I told subscribers, "Our big theme for 2005 is The Buck Stops Here." We went against everyone we knew, and we bet in favor of the U.S. dollar. We also owned several gold plays.
Some subscribers cancelled their subscriptions, saying I'd lost my mind – I was recommending both the dollar AND gold? "Impossible!" they said. "Don't you know, Steve, that, by definition, the price of gold is the opposite of the dollar, so they can't go in the same direction at the same time? And don't you know about our big trade deficit?" They said they couldn't subscribe to a letter that thought the dollar could go up in value at all.
I tried to explain to them that maybe it hadn't happened before, but it could happen. And 2005 was the year it did. The dollar rose by 15% versus the euro in 2005. And the price of gold rose by 18%. Just because the dollar rose, it didn't mean gold had to fall.
Looking back, we really nailed it... The euro and the pound have gone straight up since 2002... with the exception of 2005, when we placed our trade. Then, the dollar gained 15% versus the euro. The big reason for this gain comes down to how much a currency will buy you around the world... the currency's "purchasing power."
To give you an example, I traveled to England a few weeks ago... it's only 30 miles to Gatwick Airport from London... Even though we didn't have traffic problems, the taxi ride cost me $150!
Last week, I took a similar taxi ride in New York, from JFK Airport to Manhattan. It took more than an hour. The taxi driver had my life in his hands, darting in and out of the back streets of Queens, trying to find the quickest way to earn his flat fee - only $45.
My hotel in Manhattan was about $300 a night. In London, it was about twice that. Burgers and Cokes for two in London ran a ridiculous $60 (at the hotel restaurant).
My DailyWealth co-editor Tom Dyson is from London, but he works in our Florida office. Tom is used to London prices. When he translates his British pounds into U.S. dollars, he is absolutely flabbergasted at what he can buy.
Plenty of three-bedroom, two-bath houses are for sale around here for just a little more than 100,000 pounds (about $200,000) – within a half-mile of the ocean. He knows that the U.S. dollar is so weak, it would take an American more than $1 million to get the same house back in London.
This situation with currencies comes and goes... Back in 2001, the U.S. dollar was strong. Back then, for example, a Big Mac in Europe was cheaper than a Big Mac in the U.S. When that's the case, it's time to travel to Europe. The dollar buys a lot.
Today, a dollar buys you nothing in Europe. A Big Mac in Europe and England is 20% more expensive than one in the U.S., according to The Economist's "Big Mac Index." That's a big change from 2001.
Back in 2001, the dollar was strong. Then-Fed Chairman Alan Greenspan had put interest rates above 6%. But by the end of 2001, he had pushed U.S. interest rates below 2%. They ultimately went to 1%. Greenspan kept them below 2% until December 2004.
For those four years (2001 through 2004), the dollar weakened. Smart investors took their money out of dollars and sent their money to Europe and England, where they could earn much higher interest rates. The dollar crashed (and the euro and British pound soared) from 2001 to 2004.
By the end of 2004, the British pound and the euro were quite expensive. After Greenspan raised interest rates above 2% at the very end of 2004, we placed our bets...
When Big Macs Get Expensive in Europe...
Betting in 2005 that the buck would stop falling was the right trade to make. As investors chased higher interest rates in Europe and Britain in the early 2000s, they drove up the price of those currencies. So Big Macs in Europe reached a point where they were 20% more expensive than in the States. Whenever this happens, the euro and the pound have a hard time rising. It was time to bet against the euro.
Nowadays, the price of a Big Mac in both Europe and in England is 20% more than in the U.S. We haven't seen this since – you guessed it – the beginning of 2005.
Remember, big money flowed into Britain and Europe in 2001 through 2004 because it was chasing higher interest rates. Now Europe and England offer no interest-rate advantage... Interest rates in the U.S., Europe, and Britain are all between 4% and 6%. The U.S. dollar actually has a yield "advantage" over Europe in particular, as dollars pay about a percent more interest than euros.
So here's where we are: The euro is 20% overvalued relative to the dollar now (based on the Big Mac Index... more sophisticated studies by Deutsche Bank suggest the difference is even greater). And the euro no longer has any yield advantage, as it pays less interest than dollars, by about 1%. It's time to bet against the euro...
When we're looking for a trade, our mantra is "cheap, hated, and starting an uptrend." If we can get all three in one, we buy. Quite often, we have a hard time believing the trade ourselves, as the "hated" part is hard to get over.
But the dollar is hated now. Traders love euros. The sentiment surveys suggest that traders recently became more bullish on the euro than at any time since... well... late 2004 – the last time we bet against them. We were right, they were wrong.
We have lots of ways to bet against the crowd on this trade, with new ETFs and special mutual funds coming out all the time. But the bottom line today, is, that just like in 2005, the buck stops here.
THE CHINA BUBBLE COULD GET MUCH BIGGER...
On May 24, we posted a chart showing the low levels of "froth" in Chinese assets.
Specifically, we noted the $450 million China Fund (CHN) was trading for a discount to its underlying assets... indicating that, despite the crazy news about China's local stock bubble, Chinese assets aren't in a worldwide bubble.
Typically, country-specific funds, such as CHN, trade for 20%... 30%... even 40% premiums before a major correction hits a region. With the China Fund currently trading for a 13% discount, that correction isn't looming.
Yes, mainland China is giddy for stocks. Yes, valuations are high right now (mainland P/E ratios are close to 40)... but until we see a serious overvaluation in all things related to China, the bubble will only get bigger.