The investment climate has changed dramatically in the last two months.
For most of the last seven years the dominant theme has been dollar and US markets negative with commodities and emerging markets positive. This continued for the first half of 2008 with commodities, most notably oil, crushing US equities as the dollar hit record low after record low.
However, starting in August the dollar began a strong rally while commodities began a strong correction. Given the massive amount of leverage in the marketplace I first thought this trend reversal was the result of a short-covering rally in the dollar and over-leveraged investors in the commodities space liquidating their portfolios.
However, given the continued strength in the dollar as well as commodities’ inability to launch a significant rebound, it looks as though we may actually be at the beginning of a genuine shift in investment climate. US equities are outperforming most international indexes… and the US dollar has rallied against every major world currency you can name.
Do not get me wrong. I think the dollar is a horrible currency with poor fundamentals. The fact the US is clearly in a severe recession and adding greatly to its debt load with the Fannie/Freddie deal are all very dollar negative.
However, as investors we MUST be flexible with our strategy. And you must take your directions from the market. If the dollar has indeed begun a bull market, it won’t do you a lick of good to continue buying dollar hedges. Similarly, if US markets are outperforming their emerging counterparts, loading up on emerging markets will only add to your stress.
Right now, deflation has taken the reins. Assets across the market—particularly in housing—are losing value steadily. The large banks and financial firms continue to hold billions and billions in assets and securities that if marked to market would indicate deflation.
The regulatory bodies have tried to paper over this deflation with various inflationary tactics—printing money like crazy, issuing low interest loans to financial firms, swapping Treasuries for junk with Wall Street, etc. None of these have worked. They have built up inflationary pressures, but currently deflation is decidedly in control.
At some point in the near future, the Fed will have to really ramp up the inflationary tactics. We could very well see Ben Bernanke apply his “helicopter” hypothesis— the notion that he would print so much money it’d be as if he was dropping it from the skies— to a real world situation. When he does this, gold, silver, and other inflationary hedges—namely commodities— will explode higher.
However, currently prices across the board are falling. This is dollar positive and negative for commodities. Invest accordingly.
