Axel Merk, Portfolio Manager, Merk Funds
March 1, 2011
Merk Insights provide the Merk Perspective on currencies, global imbalances, the trade deficit, the socio-economic impact of the U.S. administration's policies and more.
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From earthquakes in New Zealand to revolutions in the Middle East, natural and man-made disasters are rocking the world. We are all too often made to believe that in times of crisis there’s a flight to the U.S. dollar. However, the U.S. dollar has instead had a rocky ride of its own thus allowing the crisis-ridden Eurozone to shine. What’s going on? Is there no crisis, or has the U.S. dollar lost its appeal as a safe haven?
Over longer periods there is little correlation between the U.S. dollar and other assets. In the past two years, however, a mentality has arisen that whenever there is a crisis the U.S. dollar benefits; as the crisis abates money flows out of the U.S. dollar and once again into currencies and markets overseas that may be deemed riskier. That may well be a skewed pendulum, however, as the U.S. dollar may have a more difficult time attracting money at each subsequent crisis. Firstly, the U.S. is simply better at spending and printing money than the rest of the world; causing the balance sheet of the U.S. to deteriorate at a faster pace than that of the rest of the world. And secondly, policy makers around the world are addressing whatever the cause of the crisis may have been i.e., the “trillion-dollar” backstop provided in the Eurozone to support weaker countries. One can argue how effective such measures are, but generally speaking, the region may be safer than before measures were taken; not safe, but “safer”, meaning less money may flee back to the U.S. dollar the next time a crisis flares up.
But maybe there is no crisis? Saudi Arabia may make up for any shortfall of lost Libyan oil production and Egypt and Tunisia don’t affect U.S. markets anyway. The argument we heard in early phases of the sub-prime crisis was “it’s all contained". Intelligent people in both Libya and abroad did not think the Egyptian turmoil would swamp over to Libya. After all, the standard of living – and with it, presumably social stability - in Libya is higher due to wealth created by oil. For now, the extreme volatility in the oil markets suggests that market participants beg to differ as to how all of this unfolds. If anything, that is a healthy process; it’s when everyone agrees that bubbles are created.
To understand the dynamics unfolding we have to dig a little deeper into the “it’s all contained” argument. People don’t like autocratic rule but we have argued that people may put up with oppression as long as they can feed themselves. Escalating food prices may be a key reason revolts and revolutions are happening now. (See also our analysis of Politics of Inflation.) However, U.S. policy makers generally disregard food inflation for a couple of reasons:
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While we believe food inflation will be with us for quite some time and may contribute to an unstable world possibly for years to come, the Federal Reserve appears to be firmly in the camp of heavily discounting food inflation. The European Central Bank (ECB), in contrast, has historically taken commodity inflation more seriously than the Fed – ECB President Trichet talks about his concern over “second round effects”, i.e., commodity inflation stirring inflation throughout the value chain.
The relevance of all this is that in the U.S. it’s business as usual as far as monetary policy is concerned. According to Fed Chair Bernanke, the U.S. economy must grow at a rate of at least 2.5% per annum just to keep unemployment stable, however, he has made it clear that he will pursue policies to boost growth above that level. With oil prices soaring, he is facing yet another headwind. Rather than mopping up the liquidity that, in our assessment, has contributed to global commodity inflation, he may be tempted to keep the printing press in high gear to promote economic growth.
It doesn’t really matter whether we think there is a crisis. What matters is that the Fed doesn’t think its policies are contributing to global instability and continues on its expansionary path. After all, the banks continue to sit on their money and as such, the economy is certainly not in overdrive. With the exception of social instability spreading globally, the Fed may be very much on course:
In contrast, the rest of the world is taking steps to stem inflationary pressures. Russia is the latest country to raise interest rates, following countries ranging from Sweden to Norway, Canada to Australia and Korea to China. In the Eurozone, the pairing down of some emergency facilities (leading to a draining of liquidity; a form of monetary tightening) and recent hawkish talk suggest interest rates may be raised later this year.
This discussion should clarify that it is perfectly possible for the world to be in turmoil without the U.S. dollar being a beneficiary. The focus of this analysis was the perceived status of the U.S. dollar as a safe haven, as well as implications of food inflation; a small, but important sliver affecting the U.S. dollar. Be sure and sign up to receive our newsletter so you will be informed as we discuss global dynamics and their impact on currencies.
We manage the Merk Absolute Return Currency Fund, the Merk Asian Currency Fund, and the Merk Hard Currency Fund; transparent no-load currency mutual funds that do not typically employ leverage. To learn more about the Funds, please visit www.merkfunds.com.
Axel Merk
Manager of the Merk Hard, Asian and Absolute Currency Funds, www.merkfunds.com
Axel Merk, President & CIO of Merk Investments, LLC, is an expert on hard money, macro trends and international investing. He is considered an authority on currencies.
The Merk Hard Currency Fund (MERKX) seeks to profit from a rise in hard currencies versus the U.S. dollar. Hard currencies are currencies backed by sound monetary policy; sound monetary policy focuses on price stability.
The Merk Asian Currency Fund (MEAFX) seeks to profit from a rise in Asian currencies versus the U.S. dollar. The Fund typically invests in a basket of Asian currencies that may include, but are not limited to, the currencies of China, Hong Kong, Japan, India, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand.
The Merk Absolute Return Currency Fund (MABFX) seeks to generate positive absolute returns by investing in currencies. The Fund is a pure-play on currencies, aiming to profit regardless of the direction of the U.S. dollar or traditional asset classes.
The Funds may be appropriate for you if you are pursuing a long-term goal with a currency component to your portfolio; are willing to tolerate the risks associated with investments in foreign currencies; or are looking for a way to potentially mitigate downside risk in or profit from a secular bear market. For more information on the Funds and to download a prospectus, please visit www.merkfunds.com.
Investors should consider the investment objectives, risks and charges and expenses of the Merk Funds carefully before investing. This and other information is in the prospectus, a copy of which may be obtained by visiting the Funds' website at www.merkfunds.com or calling 866-MERK FUND. Please read the prospectus carefully before you invest.
The Funds primarily invest in foreign currencies and as such, changes in currency exchange rates will affect the value of what the Funds own and the price of the Funds' shares. Investing in foreign instruments bears a greater risk than investing in domestic instruments for reasons such as volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. The Funds are subject to interest rate risk which is the risk that debt securities in the Funds' portfolio will decline in value because of increases in market interest rates. The Funds may also invest in derivative securities which can be volatile and involve various types and degrees of risk. As a non-diversified fund, the Merk Hard Currency Fund will be subject to more investment risk and potential for volatility than a diversified fund because its portfolio may, at times, focus on a limited number of issuers. For a more complete discussion of these and other Fund risks please refer to the Funds' prospectuses.
This report was prepared by Merk Investments LLC, and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute investment advice. Foreside Fund Services, LLC, distributor.
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Before investing you should carefully consider the Fund's investment objectives, risks, charges and expenses. This and other information is in the prospectus, a copy of which may be obtained by clicking here. Please read the prospectus carefully. Foreside Fund Service, LLC, distributor.
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