Forex

Regular readers know I’ve been pretty pessimistic on the outlook of the US economy and bearish on the US dollar as well. However, since it seems like everyone is echoing the same sentiment, could it be that we’re due for a short (or medium) term spike in the US Dollar?

According to Lou Basenese, editor of the The Alpha Intelligence Alert, think it’s time to go long the USD.
Here are some of the reasons he cites:

1. Bernanke & Paulson Rediscover “Verbal Intervention.” Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke finally got off their duffs to defend the dollar. Paulson got things started in Qatar on Sunday. Speaking to the leaders of the Gulf oil states, he urged the countries to think twice about abandoning their dollar peg, as “ending the peg is not the solution to the inflation problem.” And Bernanke stepped up today. Speaking, via satellite, to an international monetary conference in Spain he insisted Fed policy will be a key factor, “ensuring that the dollar remains a strong, stable currency.” After such a long silence, this week’s tag team approach is nothing but a positive development.

2. The “Smart Money” is Cashing In. The smart money – Wall Street institutions – tends to be a great leading indicator. If you can figure out what they’re doing in time. Right now they’re sending a clear signal – take profits on your bearish dollar bets. Case in point, as the dollar met heavy selling on May 21, the smart money took almost $100 million in profits out of Currency Shares Euro Trust (NYSE: FXE). Enough to top the Wall Street Journal’s “Selling on Strength” screen. And this isn’t the first time the ETF recently made the list. All told, the increased selling activity indicates the smart money fears we may never see such high prices again.

3. George Soros Changed His Mind. Even the smartest investors are entitled to a mulligan. After bouncing roughly 3% off the March lows, in recent weeks, George Soros told the Wall Street Journal he is now “neutral” on the dollar. And expects it to strengthen over the next 12 to 18 months. Accordingly, he “greatly reduced his bets against the greenback.” Bottom line – we should pay attention when this hedge-fund phenom changes his mind. Here’s why, copied and pasted from my first article in defense of the dollar…

“A trader named Jean-Manuel Rozan once spent an entire afternoon arguing about the stock market with George Soros. Soros was vehemently bearish, and he had an elaborate theory to explain why, which turned out to be entirely wrong. The stock market boomed.”

“Two years later, Rozan ran into Soros at a tennis tournament. ‘Do you remember our conversation?’ Rozan asked. ‘I recall it very well,’ Soros replied. ‘I changed my mind, and made an absolute fortune.'”

My guess is he will make a fortune on this change of heart, too.

4. The Fed is Done. Okay. Maybe one more cut looms on the horizon. But after that, it’s time to get back to fighting inflation and hiking rates. Futures traders awoke to this same reality once revised GDP numbers were released May 29. They ratcheted up their bets that the Fed would raise rates in late October, putting the odds at 88%. Before the release, odds of an October hike stood at 70%. As I said last time, the Fed will hike again. Soon. And such moves will immediately strengthen the dollar.
5. Busted Rhymes and Tattered Clothing. The crickets are chirping among the rappers and super models. It’s been a long time since we’ve heard (even rumors) about the world’s fashionistas and rhyme-slingers extolling the virtues of the euro over the dollar. In other words, when pop-culture embraced the dollar hating, it signaled the inflection point. And it’s time for them to get caught on the wrong side of the trade for such foolish speculation.

6. The Retail Investor is (Blindly) Headed for the Slaughter. Sad as it may be, the retail investor tends to always show up late to the profit party. Right now they’re headed to the slaughter. The proof – the number and popularity of currency ETFs literally exploded in recent years. As one long-time advisor told an IndexUniverse.com reporter, “I’ve never seen this much interest in currency ETFs before…There’s just a pile of money coming into these funds now.” And that pile, according to my research, sits around $4 billion, despite most of the ETFs being less than two years old. This reminds me of my days back at Morgan Stanley. Whenever management decided to launch our own Small Cap Growth Fund for example, because the asset class was so “hot,” the asset class was too hot. It was time to recommend our clients take profits. And now that betting against the dollar is fashionable on Main Street, it’s time we head the other direction or risk getting burned like the rest of the performance chasers.

7. New President = Clean Slate. Whether Barrack “Haven’t-Been-to-Iraq-In-A-While” Obama or John “I-Have-Anger-Issues” McCain gets the nod, a new president will get a clean slate to establish their very own dollar policy. At least temporarily. And thanks to record crude prices, expect the new Commander-in-chief to move from the current administration’s weak lip service to more meaningful actions in support of the dollar.

8. We’re Still Not Decoupled. At least not from Europe. Doubts about euro-zone growth continue to pop up. The latest – a weaker than expected composite purchasing managers index reading, compiled by the Royal Bank of Scotland and NTC Economics. The measure from across the 15-nation euro-zone slumped to 51.1 in May, the worst in nearly five years. Bottom line – the European Central Bank is in a pinch. It can’t hike rates in the face of a slowdown. And it can’t cut rates with inflation running around 3.5%. In the end, the stalemate buys the dollar time to narrow the interest rate gap.

9. Institutions are Secretly Hedging their Bets. It’s not news that international stock funds significantly outperformed U.S.-focused funds over the last seven years. Or that the dollar decline aided their outperformance. However, few realize these very same funds are now protecting their portfolios against a dollar rally. Three of the top money managers in the business (Harris Associates, Dodge & Cox and Henderson Global Investors) are now hedging up to 55% of their currency exposure. A big jump, considering the international funds from Henderson and Dodge & Cox never hedged their exposure since opening in 2001.
And last but not Least…

10. The Dollar Decline is Getting Too Long in the Tooth. As I said before, “the cyclicality of the markets instructs us that the pendulum will eventually swing back the other way.” Combine that with Einstein’s theory of relativity and one thing is clear: Although the “real” value of our flat currency may never recover, its relative value certainly will. And with the worst of the financial crisis probably behind us, I stand by my conviction. The worst of the dollar weakness is behind us, too.

Consider this my second warning that the dollar will rise. And soon. That makes now perhaps the last opportunity to position your portfolios for maximum gain.

Good investing,

Lou Basenese

If you do feel like going long, Rydex Strengthening Dollar 2x Strategy (RYSBX) is a good way to enter this trade.

If the dollar does strengthen, there’s a good chance my commodity investments (includes gold and oil stocks) and foreign currency ETFs will decline. I might use RYSBX to hedge against the rising dollar.

When I first heard about LOR, I thought it meant Lord of the Rings, but no, the topic was on Lazard World Dividend & Income Fund(LOR).

I got this email from a reader:

I love your blogs. Please tell me what to think about an odd stock – LOR. They make money from high dividend stocks AND from some sort of forward contracts involving emerging market currencies.They had a 25% yield last year but are extremely volatile ( and I don’t know why!). They have a lot of institutional investors and it looks like a good dividend pick but I don’t understand how reliable the currency contracts are. Could you do an analysis of LOR?

I’m not exactly a stock picking expert, but I’ll give it a shot. First of all I looked for LOR on Yahoo! Finance to see what it meant. I got the name of the company, the stock price graph but not much other info. That’s because it’s not a stock, but rather an ETF. Ah ha! That explains the high dividend, since I don’t know of any company that is so generous with their dividends.

Accordingly, I headed over to ETFconnect, which is a great site for finding information on ETFs. I see that its in the category of “global equity” which means it invests in world-wide stocks, just the kind of thing you’d expect from its name!

It states their investment objective:

The Fund seeks total return through a combination of dividends income and capital appreciation. The Fund may pursue this objective through a world equity strategy and a short-term emerging markets and debt strategy. The Fund may invest substantially all of its net assets in between 60 to 90 world equity securities that are financially productive and high dividend yielding. It seeks to enhance income through exposure to short-term emerging market forward currency contracts and other emerging markets debt instruments, limited to 33.3 percent or less of the total leveraged assets of the Fund, which will provide exposure to emerging market currencies.

The first part seems pretty straight-forward, but I’m not too sure what the last part entails. But at least they’re not leveraged 10 to 1 on some Subprime Real-estate Mortgage Backed Securities (RMBS) & Collateralized Debt Obligations (CDOs)! Being overleveraged is what caused Bear Stearns’ Hedge funds to collapse last July.

I also see that it’s currently trading at an 8.5% discount to its Net Asset Value (NAV). This means you can buy the basket of its shares for less than what the shares currently trade for! The current dividend yield is reported to be 8.43%. That’s strange because Yahoo! finance reported it to be 25%, a fact that I verified on Google Finance by looking at the distribution in the stock chart. It seems that in addition to the dividends, there were  long and short term capital gains distributions in December 2007, which boosted the yield.

While this isn’t a bad thing in any way, one shouldn’t buy LOR expecting to see a similar 25% yield in the future. If you’re buying it for the dividend, you should expect to receive 8.5% and be happy with it. The only concern I have is whether or not that  dividend is safe.

The ETFconnect site informs us that the fund is diversified by invested in the US (35%), th UK(23%) and other countries (42%). While it doesn’t say which other countries, looking at its top holdings we see companies like Taiwan Semiconductor, ENI and Tesltra, so we know its investing in South East Asia, Brazil and Australia. I like that global diversity.

It also seems to be diversified across various industries like finance, telecom, energy, materials, consumer staples, and so on. However, from the mix of industries it’s invested in, 32% is in the Financial Sector. That I don’t like at all. Considering that Bank of America, HSBC and Citigroup are also featured in its top holdings, I’d say thats a little to much for me. While the stocks in finance sector are currently rising on the backs of the Fed’s rate cut, I expect this joy to be short lived. And I still haven’t seen any information on its’ currency trading, debt-instrument contract or whatever it was.

So I guess it’s time to look at the company’s website, Lazard Asset Management. Here we get a little more insight to the investment objective:

*The Fund will invest substantially all of its net assets in between 60 to 90 world equity securities that are financially productive and high dividend yielding.
*It seeks to enhance income through exposure to short-term, emerging market forward currency contracts and other emerging markets debt instruments (limited to 33.3% or less of the Fund’s total leveraged assets), which will provide exposure to emerging market currencies.
These two strategies are complementary, with historically low correlation to one another, which may reduce volatility.

They may have a low correlation, but as we saw with LTCM and the recent global stock market correction, all markets are correlated to the downside. I’m highly skeptical of these statistical models that tout low correlation since they always seem to fail at inopportune moments. But at least their leverage doesn’t seem excessive. At least they’re honest and inform us that

There can be no assurance that the Fund will meet its investment objective.

But the rest of their site is actually quite informative. We already know that the stock portion of the fund is diversified across various countries, industries and capitalizations so I’ll skip over that part. But we haven’t seen much info on the currency & debt portion.

The Fund’s emerging market currency and debt strategy will also be broadly diversified across countries and regions, offering the potential for portfolio diversification- with the possibility of credit and duration protection and limited interest-rate sensitivity.

Not really sure how they’re implementing this strategy, but if it works, it would be pretty useful in current economic conditions!

They also have an interesting snippet about their dividend strategy too.

While the Fund’s equity investments are not chosen for yield alone, they will generally include the highest dividend-yielding stocks on Lazard’s equity platform, as well as a selection of stocks that may potentially have significant dividend growth. This is important because:

*Typically, dividends are real earnings, not hoped-for earnings based on the potential, future growth of a stock. They also offer the potential for stable income.
*The 2003 tax bill significantly lowered the U.S, tax rate on qualified dividend income of U.S. taxpayers.

Investing in companies with a track record of long term dividend growth is a sure fire way to beat the index averages [source: The Future for Investors by Prof. Siegal]. Investing for tax savings is not something I generally consider. First the investment has to make sense. Then you look at the taxes. If you’re so rich that you’re really worried about taxes, then maybe tax-free munies are the best route for you.

Finally, there seems to be some information on the currency trading aspects.

The Fund’s unique leveraging strategy allows greater flexibility, risk management, and economic efficiency. To enhance the income potential for investors, the Fund intends to employ financial leverage, initially up to approximately 33 1/3% of total assets, by investing in forward currency contracts and/or borrowings. Leveraged assets will be used for investing in emerging market currency or debt instruments.

It should be noted though, that the Lazard World Dividend & Income Fund, does not seek to profit from utilizing a leveraged spread-play. That is to say, the Fund is not borrowing at the short-end of the yield curve in order to invest at the longer-end of the yield curve (and profit from the spread). On the contrary, the leveraged portion of the Lazard World Dividend & Income Fund invests in very short duration instruments (typically, less than 12-months), and instead seeks to profit from accessing the high yields available in emerging market local currency debt.

Using leverage is a speculative investment technique and involves certain risks.

While its commendable that they aren’t borrowing short-term and lending long-term (remember the RMBS & CDOs I mentioned?), I get the feeling that they’re trying to profit from the carry-trade. Of course, I’m not 100% certain that’s what they’re doing, but it definitely sounds like that to me. With the Swiss franc nearly at parity with the US Dollar and the Yen up 26% in the past year, it strongly looks like the carry-trade is unwinding. In fact, they could start losing money on these kinds of trades.

To conclude, I think this is a very interesting fund. I would be amazed if they could continue to deliver 25% annual dividend yields, but 8-9% definitely seems achievable.

However, I’d look at ALPINE DYNAMIC DIVIDEND FUND (ADVDX) and even American Capital Strategies (ACAS) before I allocated any funds to LOR. Note, I’m not recommending either of the 2, I’m just saying I’d take a look at them before I made any decision.

There’s always someone at a party who’s claiming their investment asset of choices is the best. In 1999, it was stocks. In 2005, it was real estate. Right now, I’m claiming its Canadian Income Funds and commodities like gold. But is there an investment that’s actually better than something else?

Many proponents of the stock market have claimed that it is better than real estate. It’s more liquid and there’s never been a 10 year cycle where the S&P 500 had a down year. Of course, that’s rubbish. Ever try selling your stocks when the market is tanking? You’ll get taken to the cleaners. According to CNN Money, stocks follow a 16 year cycle. They go up for 16 years and then they’re roughly flat for the next 16 or so years.



Right now the Dow Jones Index is almost where it was back in early 2000. Adjusting for inflation, you’re still underwater. There’s also an often quoted comment about the stock market returning 11.5% a year over the long run. According to Ben Stein, this is factually incorrect. Over a rolling 20 year period since 1900, the stock market has on average returned just under 8%. Real estate also has had similar cycles. In Southern California, where I live, the market was down from 1991 to 1996, after booming for several years. Then in 1997 until 2005 it boomed again. Right now its falling again. Similarly in Salt Lake City, another market I follow and invest in, real estate boomed from 1991 until 1997 and then was stagnant until the end of 2004. Since 2005, its been in on the upswing again.NAR, the National Association of Real Estate, often cite the fact that nationwide, real estate has never gone down. That’s a useless fact unless you’re going to be buying a house in every major city in every state. Locally, real estate does follow periodic and somewhat predictable cycles. Between 2000 and 2005, when the stock market was tanking, real estate performed wonderfully.

And like stocks and real estate, commodities also have their own cycles. Chuck Butler , President of Everbank.com just sent me this email, “… the current Bull Market for commodities is at about 7 years and running… History shows us that (going back 200 years) that Bull Markets in Commodities have trends that last 17-22 years”. If you had bought gold in 1971 for $35/oz, you would’ve done extremely well by selling it in 1980-81 for nearly $800/oz. However, between 1982 and 2000 it languished and you might have given up and sold everything in 1999 after seeing the tremendous returns of the stock market. After all, nothing beats the stock market, right!

But $800/oz gold is here again. I’ve been investing since 2005 when it was around $500/oz. Gold has tripled since its lows of 2000 and is probably set to rally even further as the US Dollar continues its slide.

Even businesses are not free from cycles. There are times when businesses are cheap to buy (if you have the money) and are great money makers, and there are times when they are expensive (although easy with cheap money and easy liquidity) and tough to sustain at a profit.

So essentially there is no ideal investment. No single investment will yield substantial returns, year after year, for extended periods of time. Either you have to be on top of the economic factors that affect the various cycles, and keep switching in and out every few years or decades, or you need to diversify your assets so you have equal exposure to various different asset classes.

So unless you have exposure you US & foreign stocks and bonds, global real estate, currencies, commodities like oil & gas, precious metals, building materials like steel, lumber and copper, and even your own businesses, your investment portfolio is incomplete.

Claiming that one investment is better than another is just the result of ignorance. (Unless you decide to get a job as a day-trader, in which case trading indexed futures is probably the best vehicle, although the toughest to succeed at. But thats not an investment, its more like a job!)

I sold my long position in CurrencyShares Australian Dollar Trust (FXA) today. I made a nice 6% in about two weeks on it. I sold it because it gapped down and looked like it was going to drop futher in the next week or two.

The US Dollar is due for a short-term bounce which will cause the price of FXA to drop, but thinking long-term, I think the Australian Dollar will hit parity with the USD within 18 months. It isn’t a far fetched idea when you consider that 1 AUD = 1.20 USD in 1981.

Others agree with me. According to Chris Gaffney of Everbank.com:
“Fundamentals suggest the Aussie dollar will continue to rise in 2008. The economy is expected to expand by more than 4% next year, and inflation will accelerate. Overseas shipments of raw materials, which contribute about 14% to Australia’s economy, helped drive 4.3% growth in the second quarter from a year earlier, the biggest increase in three years.”

I strongly recommend Everbank’s free daily newsletter about the currency markets, the Daily Pfennig. It’s pretty good.

A technical analyst at Goldman Sachs suggested “a close above the resistance level 89.25 would set the Australian dollar free to reach parity”.

The Aussie buck traded at 88 cents this morning. Parity is only 13% away.

But in the short term I’m looking for a bit of a pull back.