Reward Far Outweighs Risk In This Sector

Written by Gerardo Del Real
Posted February 5, 2018 at 4:18PM

The dollar is off to its worst start to a year since 1987. The sell-off accelerated after U.S. Treasury Secretary Steven Mnuchin said the weaker dollar was good for the U.S.

How bad has the sell-off been?

The dollar index has hit three-year lows against a basket of currencies.

The Chinese Yuan saw its highest levels since November of 2015.

The Swiss Franc is at its highest level against the dollar since 2015.

The Sterling hit highs not seen since June of 2016 after the Brexit vote.

dollar decline 2018

The Wall Street Journal summed it up well, saying “devaluation can make the trade deficit look better for a time but it’s ultimately a fool’s game.”

Mnuchin’s dollar comments were made immediately after President Trump decided to impose tariffs on imported solar panels and washing machines.

The tariffs — up to 30% — are an attempt to target cheap imports mainly from China and South Korea.

Mnuchin’s comments aren’t the only reason for the dollar’s poor performance.

The world economy is recovering and capital is flowing into countries that appear to have attractive yields relative to the dollar.

Mexico, Argentina, Australia, India, Saudi Arabia, and all of Europe have recently seen capital inflows while countries like the U.S., China, Brazil, Russia, and Canada have all seen capital outflows.

trade-weighted index dollar

If we take a step back and look at the dollar over several decades, it’s obvious the recent dollar sell-off does not justify the "death of the dollar" cries we hear every time the dollar pulls back in notable fashion.

The market has a way of making fools out of people who make predictions, but I’m going to make one anyway: This dollar sell-off will completely reverse in the second half of this year.

What catalysts might lead to a turnaround in the dollar’s fortunes?

Here’s a few.

The recent tax package passed by Congress is meant to incentivize American companies to repatriate cash, but that has not yet materialized.

The U.S. has to finance its fiscal and trade deficit from abroad and a declining dollar is not going to attract the foreign capital necessary to continue the deficit charade.

The double talk has already begun. President Trump spoke shortly after Mnuchin’s comments and said the dollar would strengthen and that ultimately he would like to see a stronger dollar.

Regardless of the double talk, expect a weak dollar for another quarter or two and then expect a rally.

Lastly, don’t underestimate the potential for an international crisis that sends capital rushing right back into the U.S.

The recent correction in the overall U.S. indices — yes, that’s all it is — is a not-so-subtle reminder of what volatility looks like.

Then there’s the bond market.

“It feels stupid to own cash in this kind of environment.” That’s what Bridgewater Associates founder Ray Dalio told Bloomberg recently.

For nearly two years I’ve been on the record saying that the biggest catalyst for gold and gold stocks will be a break in the bond markets and capital looking for a safe home.

While that bond bubble hasn’t burst yet, air is starting to leak out slowly but surely.

Dalio feels the daily highs in the stock market will last for another 12-18 months and that asset bubbles will force central bankers to tighten monetary policy more quickly than anyone expects.

This isn’t news to long-time readers but let’s be clear that there’s a difference between me saying it and Mr. Dalio laying out the case.

He added that the bond market has slipped into a bear phase and warned that a rise in yields could spark the biggest crisis for fixed-income investors in almost 40 years.

How fragile is the bond market?

“A 1 percent rise in bond yields will produce the largest bear market in bonds that we have seen since 1980 to 1981,” said Dalio.

The interesting part of Dalio’s analysis is that it may prove conservative as his estimate does not include fixed-rate mortgages, high-yield bonds, or income derivatives.

The reference to the bond bear market in 1980-81 is not one to gloss over. The combination of high unemployment and inflation drove the 10-year yield to a record high of 15.6% in the last quarter of 1981.

Interestingly, January saw more than $36 billion flowing into bond funds. That represents the most retail money since October 2009.

Some of that money is a result of annual portfolio rebalancing, but anyone who’s traded or invested in any market knows that retail money tends to be the last to the party and is oftentimes a sign that the party is ending.

Whether you’re an aging investor looking for security or a millennial looking for leverage, commodities are at all-time lows relative to stock prices — as I highlighted last month — despite being in clear bull markets for many commodities.

crb vs spx

The risk-reward proposition is as compelling as I’ve ever seen.

To your wealth,

gerardo-sig

Gerardo Del Real
Editor, Junior Mining Monthly and Junior Mining Trader.

For the past decade, Gerardo Del Real has worked behind-the-scenes providing research, due diligence and advice to large institutional players, fund managers, newsletter writers and some of the most active high net worth investors in the resource space. Now, he is bringing his extensive experience to the public through Outsider Club, Junior Mining Monthly, and Junior Mining Trader. For more about Gerardo, check out his editor page.

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