As we foretold last month, currencies have become the pre-occupation of markets. The US dollar is now some 11% lower against sterling than at the start of the year.
Against the Japanese Yen it has fallen by 2% and against the Euro by 7%. And the most recent moves have been the sharpest. The last three months have seen an 7.5% downward jolt in the dollar against sterling.
As Zurich Club members does it matter to us? Arguably, no. We are a UK-centric group of investors, with our base currency, sterling, relatively strong.
Dollar weakness does not necessarily mean sterling strength
But ‘relatively’ is the key word. Just because our US neighbour’s currency is on the ropes, that is hardly an achievement on sterling’s part. It is an inescapable fact that the US dollar permeates the global economy. We can expect some currency-induced earnings disappointments from FTSE-100 companies when 2004 results are announced in early 2005.
Remember that the US trade deficit is just that — a deficit with the rest of the world. Each dollar of that deficit is funded by a nation outside of the US. The most prominent amongst these is Japan, which the IMF estimates is funding $160 billion of the $630 billion US trade deficit.
In addition, Japan holds around $720 billion of its estimated $840 billion of foreign currency reserves in US Treasury Bonds. That makes Japan the largest single foreign holder of US Treasury Bonds. Just like the stockmarket getting spooked when a company’s dominant shareholder reduces its stake, significant sales by Japan could crush the US Treasury Bond market. And what would it achieve? A destruction in the value of Japan’s remaining holdings and a further weakening of the dollar. In short, it’s not an option.
Japan won’t cut and run but it might spread its risk into euros and hard assets
There is a way out for Japan and other big holders of US dollar foreign currency reserves (principally other Asian central banks). That is to think like a private investor — spread the risk and hold some real assets. Above all, it will remember not to ever be the biggest holder of another country’s paper money again.
As we said last month, we anticipate a re-jigging of global foreign currency reserves into the Euro. Despite the eurozone’s own economic shortcomings, its currency is in the right place at the right time to benefit.
And that’s the beauty of being a private investor. We can exit asset classes without affecting the price. We’ve shunned US equities and viewed gold and silver _ rather than other currencies as the right way to protect us and profit from the dollar’s malaise.
For the Japanese, a weak dollar is a double-edged sword. A yen that is strong against the dollar hurts their exports, not just to the US but to all the Asian countries whose currencies are pegged to the dollar.
That is why we witness the Japanese selling billions of yen for dollars when the yen shows signs of strength.
On the sword’s other blade, that strong yen reduces the value of Japan’s mountain of treasury bonds and other dollar denominated assets. Despite our enthusiasm for Japanese equities, the dollar’s problem is very much Japan’s problem too. Little surprise therefore that the Nikkei is touching five-week lows as I write.
What should Zurich Club members do? Well, if you’ve listened to us, you certainly won’t have been holding any US dollar equities, other than those we have recommended as exceptional investments, certainly bonds, or currency deposits. There is no urgent action required. Beyond that, the dollar’s dislocation presents a major imbalance in the global economy to which all nations are exposed. The case for holding a spread of financial and real assets remains as strong as ever, and we will continue to identify companies that can prosper whatever the weather.
Maybe not soon, but one day it’ll be the right time to buy US assets again — and we’ll be on hand to let you know exactly when
With the threat comes opportunity. At some point in the future, we will be presented with the buying opportunity of a lifetime in dollar-denominated assets. Gold and Oil were two of our key themes of 2004, and already the dollar’s weakness is presenting an opportunity for sterling-based investors to gain ‘discounted’ exposure there.
In the meantime, relax and enjoy the year-end festivities. As reports come through of a $550 million derivative trading loss by China Aviation Oil, be thankful that here at Zurich Club we are long-term investors, not stressed-out traders. It’s an approach that has served us well in 2004 and will stand us true throughout 2005 and beyond. Now read on for updates on your open share positions.
ANDREW VAUGHAN, INVESTMENT DIRECTOR.
