Today's comment is by Eric Roseman, Investment Director for The Sovereign Society and Editor of Commodity Trend Alert.
Dear A-Letter Reader,
A weak U.S. dollar remains commodities' best friend. And as the dollar has finally crossed below important support levels since November 22, commodities are now getting another jolt as we shortly conclude 2006.
Historically, the U.S. dollar maintains a negative correlation to commodities. That's because commodities are priced in U.S. dollars. So as the dollar declines, hard assets priced in dollars appreciate to reflect their rising purchasing power vis-à-vis fiat money. For example, since President Nixon broke the gold standard in August 1971, gold prices have skyrocketed 2,000%, as the dollar succumbed to rising inflation and a loss of purchasing power.
Lower U.S. interest rates also act as a boon for commodities. Lower interest rates attract dollar-based assets fleeing from increasingly uncompetitive U.S. assets as rates and the dollar decline. This has been the case most recently since 2002 when the dollar peaked versus most foreign currencies. As the dollar has plunged over the last five years, virtually all commodities have surged, including crude oil, gold, and silver.
Some experts have suggested that commodities are in a "bubble," similar to technology stocks in the late 1990s. But nothing could be further from the truth. That's because most natural resource companies, unlike tech stocks, have earned a fortune over the last four years. They're even buying back their stock and increasing dividends.
Plus commodities still trade about 85% below their all-time highs, if you adjust for inflation since the peak in 1980. That's hardly a bubble by any measure. Even without adjusting for inflation, commodities are still about 70% below their highs.
Since hitting a 26-year high in May, commodities indices have now recovered about half of their losses. Corrections in a secular bull-market are perfectly normal, however severe. The CRB Index, the most widely followed commodities benchmark, continues to recover since October on the heels of a massive rally in soft commodities prices (edibles), rising base metals, and sharply higher precious metals. And energy, the largest constituent of all commodity indices, continues to build strong support this fall ahead of colder temperatures in the Northeast combined with declining inventories as we conclude Shoulder Season.
Heading into 2007, the Federal Reserve will reduce interest rates as evidenced by the U.S. Treasury yield-curve. The difference between short-term and long-term rates in the United States continues to strongly suggest that the odds of an economic recession are growing. This threat is further exacerbated by a bear-market in residential real estate, weaker retail sales, and sluggish gross domestic product (GDP) growth since July.
The Fed will ultimately do the right thing to support U.S. consumption and the real estate market: Print money.
It's time to hedge your portfolio. And the best hedges against a declining dollar in 2007 are major foreign currencies, hard assets like gold and silver, selective international stock markets, and high-value real estate.
ERIC ROSEMAN, Investment Director
On behalf of The Sovereign Society
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