HardAssetsInvestor

Mike Norman, Hard Assets Investor (Norman): Hello everybody, and welcome to HardAssetsInvestor.com. I’m Mike Norman, your host. We haven’t spoken about the dollar in a long time, about the currency markets and how that’s going to factor into commodity prices, maybe some of the commodity currencies themselves. Here to talk about it is our expert Ed Ponsi, managing director of Barchetta Capital. Ed, thanks very much for coming on the show.

Ed Ponsi, managing director, Barchetta Capital (Ponsi): Great to be here, Michael. Thank you for having me.

Norman: So let’s talk a little bit about the outlook. What's your general outlook for the dollar? A lot of people who invest in commodities look at the dollar and the dollar’s trend, because they believe a weaker dollar leads to higher commodity prices. Do you see the dollar going down or up?

Ponsi: That’s a great question. Because if you’re trading commodities, you have to pay attention to the dollar and the dollar index. The dollar’s getting in kind of a funny spot right now. It’s weak against currencies like the British pound, which is very strong right now. But it’s doing very well against the euro. The dollar’s kind of stuck in the middle right now. Overall, though, I see the dollar getting a little bit weaker and perhaps commodities also getting a little bit weaker because of that.

Norman: If you look at that dollar index … this has always fascinated me because you hear a lot of people say the Fed has printed money over the last four years, starting with the financial crisis. And certainly we’ve seen the Fed’s balance sheet go from under $1 trillion to $3 trillion since 2008. Yet in that same period of time, if you look at the dollar index — the one that’s widely followed, the DXY — that’s actually up about 7.5 or 8 percent. So it doesn’t really square with this view that we’ve printed all this money and we’ve debased the dollar. It’s actually gone up against a basket of currency; modestly, but it’s gone up.

Ponsi: Well, I look at the way that dollar index is constructed. It’s mostly based on the dollar against the euro. It’s basically about 57 percent euro in that index. So when we say that the dollar is strong against the index, we’re mostly saying it’s strong against the euro, which has its own issues, obviously.

So I think if we just look at it strictly against that dollar index, that is very heavily skewed toward the euro, because the U.S. dollar has been weak against currencies — the euro’s not one of them.

Just this week, for example, at the Summit of the Americas, we had a lot of complaints coming out of especially Colombia, Brazil. Some of the South American countries are saying, “This dollar weakness is really hurting us.” But that’s not going to show up in the index, because in the index we’re really looking at the euro.

So the euro of course has sovereign debt issues, and that’s not going to go away anytime soon. So as long as we’re looking at that dollar index, it’s a very helpful index. But we also have to keep in mind that a lot of that is skewed toward the euro. And because of that, it’s like running a race against somebody with their leg in a cast, to say “Yeah, we won, but …”

Norman: Europe’s certainly got its problems.

Ponsi: We’re damning with faint praise.

Norman: Absolutely. Let’s take a look at some of these so-called commodity currencies. You look at the Brazilian real, you look at the Australian dollar, Canadian perhaps . . . what are these currencies telling us, if anything, about just the general environment for commodities and raw materials?

Ponsi: That’s really important. If you’re trading commodities, you’ve got to look at commodity currencies. And they’re often a tell. Now I’m looking at the Brazilian real, which really got weak very recently. And of course, Brazil is a huge producer of oil, metals, copper and a lot of base metals coming out of Brazil. And I saw the Brazilian real really went down hard recently. And that is almost a red flag there for commodity prices, and it has me wondering if maybe we should, if not short commodities outright, maybe not be so bullish.

Norman: So would those currencies be more of a leading indicator, or is it more of a coincident indicator because commodities have gone done that that currency’s exchange rate has gone down? Is it a leader, or more coincidence?

Ponsi: I think there is a leading aspect to it some of the time. And one thing that’s very interesting about the commodity currencies too is they’re not all based on the same commodities. So, for example, when we look at the Canadian dollar, Canada has a lot of oil, they export a lot of oil. Australia does not. So they’re both commodity currencies, but they don’t just trade in a flat line against each other. And very clearly, there’s a big difference, because Australia really doesn’t produce any oil . . .

Norman: It’s a big gold miner though, right?

Ponsi: It’s like a huge gold mine. And really the whole country is basically selling copper and base metals and gold as well to China — coal, everything; everything China needs. So I look at the Australian dollar also as a proxy for China. I look at the Shanghai exchange and say, wow, if the stocks on Shanghai are not doing very well, I would be concerned about commodities and I would be concerned about Australian dollar.

Norman: Now are the trends in those currencies corroborating what we’re seeing right now in terms of some of the economic softness? Or are they maybe starting to suggest that period of softness is ending?

Ponsi: Two weeks ago I would have told you it looks like the softness is ending, but since then, there’s been a big emerging-market unwind. It looked like we were getting our act together with the emerging markets, but over the last week or so, it’s really unwound. And that leaves me to believe that we’re not quite out of the woods yet economically overall as far as the entire global economy is concerned. We have strong patches, weak patches; I’m very concerned about China. A lot of divergent opinions about China right now. That’s probably the big engine that I’m looking at right now.

The U.S. I feel pretty good about. Europe is Europe: I don’t have very high expectations for Europe. The divergent opinions on China are very concerning to me right now.

Norman: Europe is Europe; we all can agree with that. Let’s talk about the United States, which in 2013, we’re going to embark on our own sort of austerity program. How do you think that’s going to affect the markets?

Ponsi: Well, it really depends. Nobody really knows, I think, exactly what sort of form that’s going to take at this point.

Norman: Well, big spending cuts, and perhaps some big tax increases.

Ponsi: Very possibly. We’re not going to balance this budget next year. Obviously, it’s going to be a very long process. You cannot grow merely through cut spending and raised taxes . . .

Norman: Look at Europe: the opposite.

Ponsi: It’s not going to create growth. On the other hand, we could probably cut some of our spending, but I think it has to be done judiciously and carefully. We have to really be very, very careful about what we’re cutting and why. And as far as tax increases are concerned, again, you just have to be very, very careful, because you don’t want to raise taxes as you’re trying to create an economic recovery. That is also going to act as a drag on the economy. That’s probably something we want to avoid.

You really can’t cut spending too much right now; you really can’t raise taxes too much. And it really remains to be seen how that’s all going to play out.

Norman: I agree we shouldn’t at least do that because it would be a lot of fiscal drag. Now, no discussion of currencies would be complete I think without talking about the yen, which has been the super-currency for a long time, the safe haven for capital. When things are bad, people go to the dollar. But when things are really bad they go to the yen. And this has confounded policymakers in Japan. They want to try to get the yen down. They believe that will help them stimulate their economy. I have doubts that it will. But that’s what they believe.

Every time it’s kind of a half-hearted attempt: They get the yen to move down a little bit, they back off, and it comes right back again. What do you see as the outlook for the yen?

Ponsi: That is really a conundrum because Japan is being used as a risk-off currency. And yet there’s nothing about Japan’s economy per se that really suggests that it should be. For example, the United States, everybody who's scared …

Norman: Well, it’s very deflationary. That’s what keeps the currency very strong.

Ponsi: And in addition to that — but in the U.S., if everybody’s frightened, they’re going to buy Treasury bonds. In Japan, I think what happens sometimes is … usually there’s this interest rate differential. And you have a lot of money in Japan that would normally flow out of Japan and come to the U.S. and buy U.S. Treasury bonds. But because there’s virtually no differential in the bonds, a very slight differential, a lot of the money that normally would flow out of Japan doesn’t. It stays there. So we might as well put it in Japanese government bonds because why should we put it in Treasurys when we’re going to get the same return?

So the money stays in Japan. And that is one of the things that’s forcing that yen to just stay strong. When we saw recently the yields on the 10-year, for example, went up to about 2.3 percent, the dollar-yen started to go up with it, because then there was a differential, and folks in Japan were saying, “Ah, I can put that money in a Treasury bond. I can get a little bit of interest on this.” The money started to flow, the dollar-yen started to go up, and then what happened? Boom, right back down; right back to 2 percent on a 10-year, and the dollar-yen came right back down with it. That’s really the way I see it. It’s more like an interest-rate differential kind of play between the bonds of Japan and the bonds of the U.S.

Norman: So would that suggest the exchange rate dollar-yen kind of stays where it is? Or is the dollar-yen going to start to go back down again?

Ponsi: I think right now, because the differentials have stabilized a bit, I don’t really see any advantage to going long or short at this point. Let’s put it this way: If the yen gets too much stronger, now you’re going to have Bank of Japan stepping into the picture trying to push it the other way, which they did — actually you’d have to say, fairly successfully, last year. There were a number of occasions where they pushed the dollar-yen up rather suddenly. You don’t want to be on the other side of that move.

Norman: No, you don’t. That hurts.

Ponsi: Exactly. So I’m not going to be going long the yen against the dollar, at least not yet. But I might go long dollar-yen if we get back to around 76. Right now it’s at 80. I don’t see any chance of intervention at this point, so I’m not going to play it. But if we drop down to 77, 76 I might start to lag in, in anticipation of some action by Bank of Japan and the Ministry of Finance.

Norman: Now, if we look at the U.S. current account deficit, which went from about $800 billion back in 2005, 2006 to about $400 billion now, shrunk in half, and I think that is going to continue, because it seems our policymakers in this country believe we need to be an export nation like China. I don’t necessarily agree with that, but I’m not at the controls. So if that’s shrinking, isn’t that bullish long term for the dollar?

Ponsi: It certainly could be because it’s less money flowing out. So we look at capital flows: money flowing in and out. There’s two reasons why money would flow in or out: One is for investments; and one is for trade. So naturally there’s always an inflow into the U.S. for investments, because people want to own U.S. Treasurys, etc.

But as far as for trade is concerned, yes, I’d say that would be bullish, because that’s the other big drag on the dollar — the big trade deficit. If the U.S. can successfully export more, obviously that’s going to be good news, and that’s more money staying in. Now the question is, How do you arrive at that point?

If you weaken the dollar to the point . . . because let’s face it, countries that want to export tend to weaken their currencies. If we were to weaken the dollar, then we would certainly improve exports, but we would be making back what we were earning. We’d be creating jobs here, but everybody would be earning dollars that aren’t quite worth as much as they are today.

Norman: Our real terms of trades decline — we might sell more stuff, but we actually become poorer. Our standard of living goes down.

Ponsi: We might as well go to China and work in a sweatshop, right? They’ve got jobs, but the money isn’t quite as good. So what I’m saying is, it’s great to be an exporter, but let’s be careful about how we get there. I think we’re doing OK with the dollar; the dollar is holding steady against the euro, it’s strong against some currencies, weak against others. The dollar is not falling in any meaningful way; maybe against the pound but not against anything else. And let’s keep it that way.

If we can keep the dollar where it is and increase exports at the same time through trade deals such as what we were working out with Colombia and Brazil this past weekend, in the Summit of the Americas, if we can do that, that’s fantastic. As long as we’re getting those exports the right way — if we get it by deflating the dollar, by devaluing the dollar, that’s the wrong way to go about it.

Norman: I’ve got to ask you quickly before we end this — the Chinese renminbi, what do you see there?

Ponsi: They want to be a player. And they just recently expanded the daily range, and that’s part of the deal. They are now allowing . . . the last time I was in Shanghai, they wouldn’t allow me to take a large sum of renminbi out. Now they are allowing that.

Norman: So things are loosening up.

Ponsi: Yeah.

Norman: It’s still early though.

Ponsi: I think it’s going to take another seven or eight years, to be honest with you. Some people think you’re going to see a free-floating currency in the next two or three years. But the thing is, they have such a big advantage right now. And they just don’t want to let go of that advantage too quickly. They’re going to let it go very slowly. Why not? If you had that advantage, why would you just throw it away? They’re not going to throw it away.

Norman: All right, Ed Ponsi; thank you very much.

Ponsi: My pleasure; thank you.

Norman: That’s it for now, folks. This is Mike Norman, signing off. We’ll see you next time. Bye-bye.