Dollar Bulls and Bears Square off in the Ring… Who Wins this Year?

Happy Boxing Day and welcome back to the real world!

I’m assuming that you got plenty of family time, turkey and sweets over the last few days. If not, then I’m sure there are still plenty of goodies hiding away in festive tins in the dining room…just waiting for tonight’s midnight plunder.

But as I said just a moment ago, we’re going back to the real world. And I assumed that the best way to welcome you back would be to jump right into one of the most heated debates out there today…the future of the US dollar…

“Give me a one-armed economist!” shouted President Harry Truman in a moment of supreme frustration.

Since economists always said to Truman “on the one hand, this might happen. But on the other…” he was ready for a change. He figured a one-armed economist – being limited to a single hand – would be forced to actually make a decision every once in a while.

Unfortunately it didn’t work out for Harry…and it hasn’t changed since then.

Even today, as the world is racked by a massive financial crisis and its economic consequences, economists still can’t seem to agree. But this is rarely – if ever – a bad thing…as long as you’re open to hearing new ideas and perspectives. Sometimes you can even profit from playing both sides of the fence in different investment arenas. So it’s always worth giving a listen to what the experts have to say.

Fight Night ‘09

It’s fight night ’09, and tonight’s match promises to be a real slobberknocker.

In the red corner, sporting the white trunks and bad fundamentals, weighing in at US$10 trillion in national debt we have the Dollar bears. The Dollar bears often stick to fundamentals and focus on the overarching picture, though they acknowledge short-term strength in the face of a seemingly insurmountable credit crisis.

And in the blue corner, sporting the gold trunks and Fibonacci analysis, with a keen eye for global capital flows, we have the dollar bulls! A round of applause everyone [the crowd goes wild]…

To give you a quick pre-fight refresher, the dollar bears point to weak fundamentals and a huge amount of debt to say that the dollar is doomed. Meanwhile, the dollar bulls are less idealistic. They focus indiscriminately on the countries and the nuts-&-bolts of their economies. Essentially, the dollar bulls are conducting a “reverse-beauty pageant”...and the dollar’s prospects are looking less ugly than the competition.

In round one, they’ll be trading blows regarding the recent stutter in the dollar rally. If you haven’t been following currencies, the dollar recently fell off a cliff…losing almost all the gains it accumulated in the rally that started this September…

“As you may have noticed, volatility has been humongous in currencies lately,” says Currency Analyst and resident dollar bull, Jack Crooks.

“The huge run in the euro recently seems to have a lot of Johnny-Come-Lately dollar bulls changing their tunes. They're now suggesting the strong dollar move is done. It's time for the dollar dirt nap once again, or so they say.”

Is it time for the dollar’s dirt nap? A hard bounce last week suggested otherwise…

“I have searched the news wires this morning,” says Currency Analyst and resident dollar bear, Chris Gaffney, “and I just can’t find any good reasons for the dollar's bounce other than the dollar had simply fallen too hard, too fast.”

“One of my fellow traders and I were talking about this yesterday morning,” he went on, “as we stared at the trading screens in amazement. The dollar's move down over the past two weeks was even faster than the move up earlier this year.”

Very true. So what do the bulls say about last week’s rapid decline in the dollar index?

“Honestly,” Jack goes on, “in a market where volatility is spiking to all-time highs, it's a very tough call to suggest that a multi-day currency move means anything significant.”

“Despite the dollar's recent drop, our fundamental story hasn't changed. I still see the dollar rallying into 2009,” Jack said.

“Yesterday's news is a big part of that dollar story. We learned that China is cutting rates and Germany will contract more than expected.” This is the ‘reverse-beauty pageant’ I mentioned earlier. China, Germany and the rest of the world are getting uglier and uglier.

Jack goes on, “In other words, we're seeing once again that global demand has evaporated (Japan recently reported that November exports dropped at the sharpest rate on record).”

Is your head spinning just yet? If so, I apologize. But while they may disagree on the dollar’s recent activity, there’s one thing they don’t seem to disagree on…

Here’s the Hook;

Both parties agree that Dollar strength will be a major theme until we’re all out of the woods and the credit crisis is fully taken care of…

Chris explained some of EverBank’s core views on the dollar, “Chuck Butler [editor of the Currency Capitalist and FXU Daily] is still predicting that the dollar strength will hold as long as the contagion from the credit crisis remains in the markets. This means the dollar will be on a rollercoaster for a few months more until Fed officials finally manage to unclog the credit markets.”

Remember what Jack said earlier…that he expects the dollar to rally into 2009. And as long as the Credit Crisis doesn’t go away overnight (I checked…that’s not going to happen) then our dollar bears and dollar bulls are essentially in agreement on this point.

I think Harry Truman would smile at that.

No Good Deed Goes Unpunished

On Halloween night of 2004, Alexandra Van Horn caught a ride home from a friend. Unfortunately, she didn’t make it to her destination.

Instead, there was an accident. The car she was in careened into a light pole at 45 miles-per-hour. Believing that the car was in danger of exploding, her friend Lisa Torti pulled Alexandra’s injured body from the smoking wreckage. At the hospital, Alexandra found out that she sustained injuries that would leave her a paraplegic for life.

So what’d she do? She sued her friend Lisa…of course.

“You’re going to have to go over that whole story for me again,” I told our Privacy & Rights expert, Mark Nestmann. He explained that – despite California’s existing Good Samaritan law – Lisa could still be at fault here. Thanks to the ‘legalese’ in which the Good Samaritan law was written…

“The decision comes despite the plain wording of the state's Good Samaritan law,” Mark explained to me, “which reads:

“No person who in good faith, and not for compensation, renders emergency care at the scene of an emergency shall be liable for any civil damages resulting from any act or omission.”

“However,” he went on, “the court magically inserted the word "medical" after the word "renders" to interpret the law as providing protection only to those providing emergency medical treatment. If you're merely pulling someone from a smoking vehicle that's about to explode, and that person alleges injury as a result of your actions, you're not covered.”
So what’s a Good Samaritan to do?

“Even if you live in a state with a ‘strong’ Good Samaritan law, you can still be sued if you botch a rescue attempt. You'll need to hire an attorney to defend yourself, take time to prepare a defense, and hope that you prevail. Liability insurance can pay some or all of these expenses, although insurance companies can and do contest some Good Samaritan claims”

“In some states, you have a legal obligation called a "duty to rescue" to assist someone in distress. This is particularly true if you're a medical professional or work in emergency services. But, absent this duty, intervening in an emergency situation is an invitation to a lawsuit.”

MARK NESTMANN,
Privacy Expert & President
of The Nestmann Group
www.nestmann.com

What a world, what a world.

You’ve seen some grumblings in the A-Letter for the last few weeks about Corporate Debt. Specifically the Investment-grade flavor. But Investment Director Eric Roseman is taking a closer look at the whole thing…

He’s looking at the balance sheets of some of the world’s biggest countries and companies and asking who poses less of a credit risk…you might be surprised at the answer.

Yours in Personal Sovereignty,

MATT COLLINS, A-Letter Editor

SPECIAL COMMENT:

Is Investment Grade Corporate Debt
Safer than Government Bonds?

Several segments of the credit markets have come back to life in December after crushing losses recorded in September and October. Though it’s too early to celebrate a broad based credit revival, the largest issuers of investment grade debt surged this month as yields plunged. Mortgage-backed bonds, or agency debt, have also rallied sharply in December on the heels of government guarantees and the Fed’s plan to spend $500 billion dollars to shore up the sector.

With the United States and other governments amassing a truckload of debt to finance state sponsored bailouts of financial services and fiscal spending plans, it is conceivable that investors will increasingly swap low-yielding T-bonds for high quality corporate debt in 2009.

Since hitting a post-crisis peak of 4.88% in October, three-month LIBOR (London Interbank Offered Rate) has plunged to 1.52% on December 19. On December 1, LIBOR stood at 2.22%. A lower LIBOR rate is the first indicator to finally emerge from stress amid the credit crisis. Banks are still largely hoarding cash but several large institutions have started to lend in overnight markets this month for the first time since late 2007.

The Growing Yield Dilemma

The Federal Reserve’s latest interest rate cut to effectively 0% on December 16 has laid the foundations for more trouble at money-market funds where yields for 30-day and 90-day Treasury bills continues to fetch just 0.01% – the lowest in more than six decades. Earlier in December, 30-day bills actually turned negative for the first time since 1940. That means investors are paying the government to park cash.

Money market funds are now sitting on potential losses as management fees erode the yield generated by Treasury bills and other short-term paper. Though other debt securities yield more than T-bills, investors might be embracing more credit risk as fund companies look to boost yield.

A better alternative to money market funds include one-year term deposits (CDs), short-term investment grade bonds and even intermediate-term corporate debt. Term deposits should be held only at the nation’s biggest banks, including J.P. Morgan Chase, Wells Fargo and Bank of America.

Yield Hungry? Here’s a Free Lunch

The Fed’s latest moves to spur lending in a massively credit-inflicted bear market since 2007 is forcing many investors to turn to distressed corporate investment grade bonds. The effective yield on the benchmark Dow Jones Corporate Bond Index is 7.23%, down from a record high of 8.88% just a few months ago and down from 8.06% on November 30. A lower yield means corporate bond prices are rising in value.

In September, investment grade bonds were hammered following the collapse of Lehman Brothers Holdings and posted their single worst month of performance since February 1981. Many bonds plunged more than 15% in September alone.

More than half of the investment grade bond sector is comprised of financial services debt or bonds issued by some of the largest banks in the United States and Europe. With the Fed’s implicit guarantee on the largest issuers of such debt, investors can now tap into bank issued bonds trading at a 5.16% premium to expensive Treasury bonds.

For a portion of an investor’s liquidity, corporate high quality debt is literally a “free lunch.” The largest issuers of corporate paper have started to return to the market since November, including IBM and other large cap companies. In Europe, some banks without government guarantees have managed to raise sizable offerings – a positive development.

Corporate Debt: The New Safe-Haven?

Since October, governments in the United States and Europe have swapped government paper for toxic mortgage-backed assets previously held at banks. Despite these efforts, most banks are still laced with all sorts of other clogged credits like leverage loans, auction rate securities and repo credits.

The credit crisis has not disappeared because of aggressive government and central bank action; rather, swaths of credit risk has been transferred from bank balance sheets to government balance sheets, effectively polluting central bank coffers with largely illiquid and near worthless paper. Since August, the Fed’s balance sheet has mushroomed from $850 billion dollars to more than $1.5 trillion dollars – and still rising.

Indeed, credit default swap rates since October have risen sharply on government paper while swap rates have decreased for the highest quality companies. This suggests investors are starting to place a risk premium on government issued bonds.

Are we at the cusp of a major transition in the credit markets whereby investors might increasingly purchase investment grade debt as a hedge against rising yields on government bonds? After all, outside of the financial sector many industries harbour their highest net cash levels in more than a decade. For some companies, especially the food and beverages and fast-food companies, cash flow is largely generated internally and, in most cases, these companies don’t need to raise cash to finance operations. I would argue that companies like Kraft Foods, General Mills and McDonald’s are a better long-term credit risk than most sovereign borrowers.

Failed Auctions Rising

To confirm the above theory that perhaps investors are starting to embrace riskier bonds like investment grade debt because of bulging government deficits, consider the trend in Europe since October whereby several governments have scrapped bond auctions.

Over the last sixty days, Germany, the Netherlands, Italy, Spain, Austria and the United Kingdom have either scrapped bond auctions or reduced their planned offerings because of tepid investor interest. These governments, including Germany, the largest and most liquid, are paying higher yields to draw institutional buyers. This could mark the beginning of a bear market for government bonds at some point later in 2009, once credit markets stabilize and risk taking is resumed.

In the United States, demand for Treasury’s remains strong because of fears of deflation. The current environment – a disaster for just about every asset class except T-bonds – has supported the dollar to an extent. Foreigners are chasing Treasury securities as they scramble for safe havens. Yet even Treasury is not immune to the deluge of supply coming our way in 2008.

Over the next 12 months Treasury estimates it will have to raise about $1.5 trillion dollars to fund gargantuan fiscal spending plans, bailouts, and possible tax cuts. Treasury will re-introduce one-year, three-year and five-year T-bonds in 2009 to finance part of this spending spree. At some point, investors will force long-term rates higher. The Fed will try to influence the long end of the yield curve but will ultimately be unsuccessful. The Fed can only control short-term lending rates.

Investment grade bonds shouldn’t supplement T-bills. The risk spectrum is normally quite significant in a normal economic environment. Yet these are anything but normal economic times. It is possible that as 2009 progresses and, assuming credit markets continue to grudgingly normalize, the new safe haven in bonds will be high quality investment grade bonds at the expense of super low-yielding Treasury debt.

ERIC ROSEMAN,
Investment Director,
The Sovereign Society