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How To Play The Demise Of The U.S. Dollar

The US dollar currently is the world’s reserve currency. What that means, other currencies are ‘backed’ by the dollar. Foreign central banks hold US dollars as a reserve, making their own currencies more valuable. It has replaced the previous standard, the gold standard because the USD was ‘good as gold.’ There seems to be an underlying fear that the US dollar will be ‘replaced’ by an alternative such as the Chinese yuan, Russian ruble, Arabic dinar, amero, or some other ‘One World Currency.’ We’ll display here facts proving that this is impractical for the next 20 years at least. The latest threat comes from Saudi Arabia. A new law would allow families of victims of the tragic events of 9/11 to sue a sovereign government, Saudi Arabia, for involvement in the attacks of some kind. WSJ has written an explanation of what it means and how it can impact markets: President Barack Obama ‘s trip to Saudi Arabia this week and pending legislation that would enable families of people killed in the Sept. 11, 2001 terrorist attacks to sue the Gulf kingdom have prompted fresh calls to declassify 28 pages of a congressional report said to describe links between Saudi Arabia and the terrorists. “If all of the information comes out and [the legislation] is passed we can move forward against the Saudis,” said Jim Kreindler, one of the lawyers representing the families of Sept. 11 victims. But is it really feasible, that the Kingdom sells huge amounts of US assets? Marc Chandler proposed the most recent analysis in a recent article on the topic : There is something else Saudi Arabia could do. It could take a page from the playbook of the former Soviet Union. When it saw how the US treated its special ally Great Britain in the Suez Crisis, the Soviet Union was wary of the US using its financial power for political ends; it feared that its assets in the US could be frozen. It took the dollars it had in the US and deposited them with a UK merchant bank. That merchant bank was able to lend out those dollars without the interest rate cap that prevailing in the US at the time. This is to say that the offshore dollar market was launched not by good capitalists and the internationalization of savings, but the Communists seeking to move out of reach of US officials. Saudi Arabia could do the same thing. It could takes its US Treasury holdings and bring them to a foreign custodian, who is not subject to US laws. This may be more difficult to do with some of the other assets it may own in the United States. Overall this course would prove to be less disruptive for it than selling Treasuries. That means, there are a number of practicalities not considered by those who promote this idea that somehow a foreign power such as Saudi Arabia, China, Russia, or others; could trigger a US markets event that could lead to a run on the US dollar. Could it happen? Of course. But if it did happen, even in the worst case scenario, there are number of protections in place (similar to ‘circuit breakers’) that would prevent something extreme. Electronic markets mean that on the one hand, information ripples around the world at light speed, and institutions can make decisions in seconds and with 1 click sell or buy trillions in assets. But on the other hand, they have allowed the consolidation of control into one power. In the case of the stock markets, that’s the exchange. The NYSE reserves the right to halt trading or implement other measures, should a situation such as 9/11 occur. This has never happened in currency markets, but if it did, the Fed could literally halt US dollar markets around the world. Because the Fed controls all US dollar payments. It could be impossible to ‘sell’ the dollar, at a rate that would create severe decline. Also remember that the Fed works in conjunction with other central banks, to provide US dollar funding (among other functions): In response to mounting pressures in bank funding markets, the FOMC announced in December 2007 that it had authorized dollar liquidity swap lines with the European Central Bank and the Swiss National Bank to provide liquidity in U.S. dollars to overseas markets, and subsequently authorized dollar liquidity swap lines with each of the following central banks: the Reserve Bank of Australia, the Banco Central do Brasil, the Bank of Canada, Danmarks Nationalbank, the Bank of England, the European Central Bank, the Bank of Japan, the Bank of Korea, the Banco de Mexico, the Reserve Bank of New Zealand, Norges Bank, the Monetary Authority of Singapore, Sveriges Riksbank, and the Swiss National Bank. Those arrangements terminated on February 1, 2010. In May 2010, the FOMC announced that in response to the re-emergence of strains in short-term U.S. dollar funding markets it had authorized dollar liquidity swap lines with the Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank. In October 2013, the Federal Reserve and these central banks announced that their existing temporary liquidity swap arrangements–including the dollar liquidity swap lines–would be converted to standing arrangements that will remain in place until further notice. And remember – currencies are traded in pairs – so if the US dollar is ‘sold’ – something must be ‘bought’ – it’s not like a stock. It’s not possible to sell the US dollar without ‘buying’ something else, such as the Euro, Pound, Swiss Franc, or Gold. Looking at it from one perspective, although forex markets are completely unregulated, they are also completely manipulated. That’s because the central bank controls its own currency completely. Central banks cannot control other currencies, only their own – which is why they usually work together, through institutions such as the BIS. In any event, during a currency crisis of any kind, like minded nations would turn to each other and the BIS. But investors must understand that modern Forex is a closed system, as explained in detail in the “Splitting Pennies” book. If any currency poses a threat to the US dollar – it’s bitcoin, not the yuan. That’s because bitcoin is not manipulated, and not inside the forex system – it’s an externally manufactured currency, not created by a central bank. The problem with our modern forex system is that there are 10 myths for every 1 fact, and they don’t teach it in school. Finally, these fears about China somehow smashing US markets by a fire sale are completely unfounded. First, China is incapable of managing its own economy . They say the western fiat economic monetary system is a ‘Ponzi’ – if it is, then China is a super- Ponzi . Don’t forget the history – China’s economy is just about as old as the Forex market itself. It needs time to evolve and grow. There are still many elements in the Chinese economy which are missing, but are necessary for a financial world leader capable of managing a world reserve currency. Yes, they are taking steps, such as the recent gold price fixing . But these are baby steps, it will take decades before China can crawl, walk, and finally run. At the moment it relies on US support, financially, politically, and economically. The US is currently China’s biggest customer. It’s a cozy relationship – the US prints US dollars and sends to China, China sends manufactured junk to the US. This is one leg that supports the US dollar, created by Richard Nixon. The other leg being the petro dollar system. By recycling US dollars in US markets, it ties China to the US as well, provides natural demand for USD. For China to completely abandon this system, would crash their economy. America is capable of producing cheap junk, should the need arise. It would even be politically popular, and regenerate the US manufacturing sector. But China is incapable of creating by itself, a world class banking system. They need western involvement, even if it’s a simple copy and paste operation. China is not Japan – it can take China 100 years to adopt western systems, or longer. They have long term thinking, which is a good thing generally, compared to the quick timeline of Western thinking. But insofar as there is any threat to the US dollar, from China, Saudi Arabia, or elsewhere, it’s preposterous. So although we have debunked these myths about the fallacy of real paradigm shift in regards to the US dollar, all these new players may provide pressure on the US dollar, as some choose to sell their US assets in favor of new systems, especially regional players who until now, didn’t have a choice other than the USD. Currently the US dollar has a monopoly on the global Forex market which isn’t a good thing. Competition is healthy, it will ultimately make global markets more stable. At the end of the day, the US dollar is supposed to create an environment for markets to exist, not be a market itself, which it has become. Ways to trade the fear of US dollar Demise 1. Short USD ETFs (NYSEARCA: UUP ) and (NYSEARCA: USDU ). ETFs offer great alternatives to Forex because of their availability in stock markets, and their wide variety of options. UUP has options going out 2 years, to 2018, with decent liquidity. By trading options on an ETF, you have the security of US regulations and the security of US protections against fraud. Broker-dealers don’t go bust often like Forex brokers do, and are regulated by FINRA. Also, for some it may be convenient to hold these contracts in the same account for which you do your other investing. 2. Long Gold & Silver. There are many ways to play gold and silver. The most popular gold ETF is (NYSEARCA: GLD ) and the most popular silver ETF is (NYSE: SRV ). Similar to other ETFs, deep out the money options provide a great way to play this strategy, and will provide the best bang for the buck. One futures strategy employed by some traders, to buy the Gold contract and not roll it over, thus receiving delivery of the underlying. Futures trading offers a great alternative to stock ETFs , as you would be trading the actual commodity itself, in this case Gold & Silver. 3. Long Forex banks Any bank that utilizes multiple currencies, such as Everbank (NYSE: EVER ), will profit from their strategic positioning. Banks who do business in emerging markets, who will capture this new Forex business, will profit too. The point here is that when China comes online completely, it will be a good thing – it’s a new customer. Don’t worry though, markets will be organized by western banks for as long as all of us are alive. We just have too much of a head start. In conclusion, be wary of claims made by those who do not fully understand how the global Forex system works. The US dollar will have less and less role to play in the world – US dollar hegemony was an accident. Forex was an accident, created by a US President, Richard Nixon. At the same time, Nixon opened China, and we are now seeing the result of those protocols – China is close to having a real free market system (just remember to bring your stomach medicine if you visit, or bring your own food and water). Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Sector ETFs To Benefit From Global Negative Interest Rates

The world is heading toward negative interest rates policies (NIRP) to stimulate sagging growth and prevent deflationary pressure. Most central banks, including the ones in Japan, Sweden, Switzerland, Denmark and Europe have adopted this policy. The central bank of Denmark was the first and foremost to set a negative tone for rates in mid 2012. It lowered its certificates of deposit ( CD ) rates to minus 0.20% from 0.05% in order to protect the krone’s peg to euro. Then the Danish central bank underwent a series of rate cuts in January and February 2015 going deeper into -0.75%. However, in January 2016, the bank raised the interest rates for the first time in almost two years by 10 bps to -0.65% (read: 5 Best Performing Country ETFs of 2015 ). The European Central Bank (ECB) joined the group in June 2014 by slashing the deposit rate from zero percent to -0.1%. The ECB then pushed the rates further to -0.3% in December 2015 and deeper to -0.4% on March 10, 2016. Switzerland introduced negative interest rates in December 2014, when the Swiss National Bank said it would charge banks 0.25% interest on bank deposits in an effort to curb its strengthening currency. The Swiss bank pushed the rates further into the negative territory to -0.75% in January 2015. Swedish Riksbank implemented negative rates in February 2015 when it cut repo rate to minus 0.1% from zero. The bank reduced the rates three times since then with the latest cut by 15 bps in February 11, 2016 to -0.50%. Last but not the least, Japan was the latest country to join the league in late January 2016 as the Bank of Japan set its benchmark interest rate at -0.1% (read: Japan ETFs to Buy on Negative Interest Rates ). NIRP: A Good or Bad? Though the negative rates policy has raised worries over the health of the banks and increased chances of default, it is actually a good for the economy and the stock markets. This is because the strategy would make lending cheaper and encourage spending, thereby leading to greater economic growth. In addition, it would make borrowing attractive for both consumers and business, driving demand for loans. As such, it will give a huge boost to sectors like real estate, housing and utilities. Further, NIRP would lead to capital outflows leading to depreciation of the currency, which will encourage exports and manufacturing. Investors should note that the NIRP policy has not been tested before and so, does not have any history. Given this, many investors want to reposition their portfolio to the sector ETFs that will benefit from NIRP. Below we have highlighted some of them: Vanguard Global ex-U.S. Real Estate ETF (NASDAQ: VNQI ) This fund offers a broad exposure across international REIT equity markets by tracking the S&P Global ex-U.S. Property Index. Holding 663 stocks in its basket, the fund is well spread out across components with none holding more than 3.3% share. European firms account for 26% of assets, while Japan makes up for 24% share, and Sweden and Switzerland getting 2% each. The product has AUM of $3.1 billion and average daily volume of 316,000 shares. It charges 18 bps in fees per year from investors and has lost 0.22% so far this year. WisdomTree Japan Hedged Real Estate Fund (NYSEARCA: DXJR ) This fund seeks to provide exposure to the Japanese real estate sector while at the same time offers hedge against any fall in the yen relative to the U.S. dollar. This is easily done by tracking the WisdomTree Japan Hedged Real Estate Index. In total, the fund holds 93 stocks with each holding less than 8.5% share. Expense ratio came in at 0.48%. The product has accumulated $145.8 million in its asset base and trades in a moderate volume of 63,000 shares a day on average. DXJR is down 4.8% in the year-to-date timeframe and has a Zacks ETF Rank of 2 or ‘Buy’ rating with a Medium risk outlook. iShares FTSE EPRS/NAREIT Europe Index ETF (NASDAQ: IFEU ) This product targets 96 companies engaged in the ownership and development of the developed European real estate market. It tracks the FTSE EPRA/NAREIT Developed Europe Index, charging investors’ 0.48% in expense ratio. The fund is less popular and less liquid in the European space with $64.3 million in AUM and average daily volume of around 23,000 shares. IFEU has lost 6.2% in the year-to-date timeframe. WisdomTree Global ex-U.S. Utilities Fund (NYSEARCA: DBU ) This fund follows the WisdomTree Global ex-US Utilities Index, which measures the performance of the dividend-paying companies in the utilities sector of the developed and emerging equity markets, excluding U.S. European firms account for 54% of the portfolio while Japan takes 5% share. With AUM of $14.4 million, the fund is diversified across 97 securities with none holding more than 2.5% share. It charges investors’ 58 bps in annual fees and trades in a paltry volume of 4,000 shares a day. The ETF has shed 0.5% so far this year. Link to the original article on Zacks.com

10 Charts That Explained Markets In 2015… And Will Impact 2016

Summary 2015 will be remembered for weakness in commodity markets, which bled over into global equities and U.S. high yield debt. In 2016, the divergence between monetary policy in the United States and the rest of the developed world could shape global financial markets. Underpinning all global markets is the ongoing transition of the Chinese economy from one driven by fixed investment to one led by domestic consumption, an unrivaled economic experiment. Below are what I believe are ten of the most interesting charts of 2015. The topics depicted had outsized impacts on financial markets in 2015, and will continue to be important considerations as the calendar turns to the New Year. While oil stole many of the headlines in 2015, falling by nearly two-thirds over the past eighteen months, a broad commodity index moved to its lowest level since 1999. Industrial metals, precious metals, and agricultural commodities were all pressured by a slowdown in global growth. Global Commodities Trade at 16-Year Low (click to enlarge) Source: Bloomberg, (Data through mid-day 12/24/15) Stress in commodity markets was primarily blamed on moderating Chinese growth. While the Chinese growth rate has receded, the absolute change in the size of the Chinese economy was still roughly equivalent to its absolute growth in 2006 and 2007 when the economy was growing at double digit growth rates. In 2015, the Chinese economy grew in absolute terms by the size of the entire Swiss or Saudi Arabian economies. Said differently, the Chinese economy still grew in nominal terms by the size of all the goods and services produced in Switzerland in a year. The China effect on commodity prices has been less of a function of flagging growth rates, and more of a function of the party’s efforts at transitioning the economy from an investment-led to a more domestic consumption-driven economy. Chinese Economic Growth in Absolute Terms is Still Tremendous Source: Bloomberg, World Bank While China had an impact on commodity prices, the strengthening dollar also was a big story. When the value of a dollar rises, it takes fewer dollars to buy a given commodity. These global commodities traded in dollars also become more expensive in local terms, potentially reducing demand. As the graph below shows, the dollar is at its strongest points versus a basket of global peers in the last decade-plus. As the Fed normalizes monetary policy further, higher interest rates on dollar investments could also spur a rally in the greenback, which could further pressure commodity prices and U.S. exporters and multinationals with large foreign businesses. The U.S. Dollar Index Strengthens Against Global Peers (click to enlarge) Source: Bloomberg, (Data through mid-day 12/24/15) A key theme in 2016 could be the divergence of U.S. and European monetary policy. Lend money to the German government today for ten years, and they will pay you 0.64% per year. In April, that figure was an astonishing 0.075%. That figure is still negative for 10-yr Swiss government bonds at -0.09%, meaning investors pay for the privilege of the Swiss government to hold their money in Swiss francs. Higher interest rates in the United States could continue to rotate money from the low rates in the developed world (Europe and Japan) and more stressed emerging economies. Shifting capital flows will create volatility and opportunity. German 10-yr Highlights Ongoing European Economic Weakness Source: Bloomberg Speaking of volatility, U.S. investors may have been unnerved by an uptick in market volatility in 2015, but that volatility paled in comparison to the volatility on the shallower Shanghai exchange. Chinese Volatility Could be Part of New Normal (click to enlarge) Source: Bloomberg, Standard and Poor’s One of my key themes has been the long run risk-adjusted outperformance of lower volatility assets relative to their higher beta cohorts. I wrote an expansive series this summer on the L ow Volatility Anomaly , or why lower risk stocks have outperformed their higher risk brethren over time. That theme continued in 2015 as a low volatility component of the S&P 500 outperformed high beta stocks and the broader market gauge on an absolute basis. Low Volatility Outperforms (Again) (click to enlarge) Source: Bloomberg, Standard and Poor’s; (Data through 12/23/15) This preference for lower volatility assets also extended to the topical high yield bond market ( as described in this piece ). Driven by the underperformance of commodity-sensitive speculative grade bonds, the High Yield Index is under the most stress since early in the economic recovery in 2009. This stress can be seen by the sharp underperformance of lower rated riskier ratings cohorts versus the performance of the higher rated BB junk bonds. Chasing Yields Led to Bad Outcomes in High Yield Source: Barclays; Bloomberg While the last two graphs compared different quality classes within an asset class, the next graph depicts the volatility of the 30-yr Treasury versus the S&P 500. As one would expect upon the unwind of vol-suppressing extraordinary monetary accommodation, interest rate volatility increased in 2015 as shown by the variability of the performance of long duration Treasuries. For investors seeking shelter from equity volatility in fixed income, long duration securities with higher interest rate sensitivity may not be the haven for you. (This is a topic I have also covered in the past through an examination of the volatility of the bonds and equity of Apple (NASDAQ: AAPL )). Equity vs. Rate Volatility (click to enlarge) Source: Bloomberg; Standard and Poor’s; U.S. Treasury The Fed rate increase was in large part driven by a firming in the labor market that pushed the unemployment rate down towards its estimated natural rate of unemployment. A different perspective of the labor market shows that labor force participation is at its lowest level in nearly forty years. While we have seen a cyclical recovery in employment figures, the economy still faces secular headwinds from an aging population. Perhaps, there is more slack in the labor market than suggested by official employment statistics. If so, the failure of wage inflation to materialize could increase the risk of policy error by the Fed. How Healthy is the Labor Market? Labor Force Participation at Multi-Generational Lows (click to enlarge) Source: Bloomberg, Bureau of Labor & Statistics; (Data through 11/30/15) The weak economic recovery post-crisis has kept the U.S. economy from operating at its full potential. Limited investment by a necessarily more austere government after record cyclical deficits has pushed the average age of government fixed assets to its oldest age on record. Similarly, corporations have been more apt to invest in their own securities through record share buybacks than undertake capital investment in the real economy, extending the age of the private capital stock. Older fixed assets and infrastructure could be another structural headwind that pressures domestic economic growth. A Growth Drag from Aging Infrastructure? Source: Bureau of Economic Analysis 2015 was a fascinating year in financial markets. Plunging commodities, flagging Chinese growth, ultra-low rates in Europe, and the underperformance of higher risk investments in the United States all were symptomatic of tumultuous global markets. Domestically with equity multiples still above historical averages and yields on investment grade assets still historically low, forward returns are likely to fail to compensate investors for a continued heightened volatility. Disclaimer: My articles may contain statements and projections that are forward-looking in nature, and therefore inherently subject to numerous risks, uncertainties and assumptions. While my articles focus on generating long-term risk-adjusted returns, investment decisions necessarily involve the risk of loss of principal. Individual investor circumstances vary significantly, and information gleaned from my articles should be applied to your own unique investment situation, objectives, risk tolerance, and investment horizon.