Thursday, May 18, 2006

 

Emerging Market Currencies Tumble Vs. US$

A Bloomberg report on Latin American currencies. "The currencies of Brazil, Colombia and Mexico will extend declines into the third quarter on concern rising global interest rates will reduce the attractiveness of emerging market securities, according to Merrill Lynch."

"The Brazilian real, last year's best performer against the dollar, has weakened 6.8 percent since the Federal Reserve increase its key rate on May 10 and suggested it may boost rates further to control inflation. The Colombian peso has dropped 4.7 percent, while the Mexican peso has lost 2.9 percent."

"'It's not related to one specific market, or to elections in Brazil or Mexico,' said Daniel Tenengauzer, an emerging markets currency strategist for Merrill Lynch. 'It starts from the outside world; the Bank of Japan and ECB may start hiking; the housing market in the U.S. is cooling down. Hiking banks will lead to a drain in liquidity and global slowdown.'"

"The real dropped 3.3 percent to 2.2095 in New York yesterday and is down 5.9 percent this year. The Colombian fell 1.7 percent to 2455.50 yesterday and the Mexican peso declined 1.5 percent to 11.2052 per dollar. The real may weaken to 2.40 per dollar by the end of June, the weakest since August, Merrill Lynch said. The firm forecast the Colombia peso to weaken to 2450 in the same period, and its Mexican counterpart to settle at 11.10."

"Emerging market currencies, including the Polish zloty and the South African rand, fell yesterday after a U.S. report showed consumer prices increased faster than expected in April, adding to speculation that inflation may be accelerating."

"Monetary policy within each of the Latin American nations will be one of the key factors determining which currencies of emerging markets will be most vulnerable to investment outflows, Tenengauzer said. 'Central banks consistently missing inflation targets could get punished.'"

"The Brazilian central bank has lowered its benchmark lending rate seven times since September, to 15.75 percent. Policy makers in Mexico reduced the overnight lending rate to 7 percent from 7.25 percent on April 21."

Comments:
Morgan Stanley Chief Economist Warns of Commodities Bubble

Excerpt:
BOSTON (MarketWatch) -- Morgan Stanley Chief Economist Stephen Roach thinks there's a speculative bubble in commodities, and it's not a matter of if it will burst, but when.

"Like clockwork, liquidity-driven investors have migrated from asset to asset, desperately in search of yield," he said. "The world is now in the midst of another bubble -- this one in commodities." [this is what I've been arguing]

"Like Nasdaq, irrationally exuberant commodity markets will also be taken by surprise," he said.

"Play the commodity bubble of 2006 at your own peril," the economist warned.

 
the good news is now that we know commodity prices are a problem, it's not a problem...
 
I typically agree with Roach, although anyone who has followed his analysis knows that Roach *always* blows the whistle much too soon. He started screaming about the housing bubble in early 2003 (as did the Economist magazine, and many others btw), and missed out on the greatest asset bull run in the last 10 years.

Roach, in the past, defined a "bubble" as (I paraphrase) a price increase based purely on speculation: where the fundamentals have ceased to drive the price higher, and expected increases alone are what drive higher gains.

It strikes me that "Bubble" is a strange word to use in the case of gold since gold is the traditional "safe haven", "store of value" investment. Because gold is where banks, institutional investors and funds historically "run to" when global market instability increases, its value is frequently determined by a host of geopolitical factors, currency moves, inflation fears, etc. One could therefore equally argue that there is a "Bubble in US Dollars" as its fundamentals couldn't look shakier but we see (particularly this week) that an unfounded belief in its ability to "store value" persists. Clearly this is historically untrue.

If you believe (as Roach does) that gains in commodities are being driven by an expectation of increased consumption, then clearly commodities appear to be a bubble. (And you should hold dollars). But if you believe that gains in commodities are being driven by expectations of increased value relative to currency declines, then the fundamentals are actually very solid.

Personally I fall in with the latter argument. As long as the dollar tracks downwards, commodities prices will be driven (relatively) upwards. This isn't speculation on commodities prices per se -- its speculation on decreasing dollar valuations. And that speculation is based on the hard math of US debts, balance of trade, manufacturing decline, population dynamics and a host of internal financial burdens from pensions to military obligations to social security.

Currencies, as a whole, are in for a very rough ride.
 
wow, that's a great explanation
 
missed out on the greatest asset bull run in the last 10 years.

Just the other day I read about a cab driver who is desperately trying to unload five homes he bought on spec in Phoenix. There are tens of thousands like him trying to dump properties in LV, FL, TX, DC, Bakersfield, etc. I'll bet they wish they had also missed out on the greatest asset bull run in the last ten years. The truth is, a few people make money in speculative bubbles, but the majority hang on too long and get stucco.

If you believe (as Roach does) that gains in commodities are being driven by an expectation of increased consumption, then clearly commodities appear to be a bubble. (And you should hold dollars). But if you believe that gains in commodities are being driven by expectations of increased value relative to currency declines, then the fundamentals are actually very solid.

You got that exactly backwards. If you think the gains will come from increased consumption, you're investing on fundamentals. If you're motivated by expectations of further price gains due to a decline in the dollar, you're engaging in currency speculation. There's nothing inherently wrong with that (George Soros has made a fortune in currency speculation), but it is speculation, not investing.

If you're jumping into PMs because the price is going up (as I believe most hedge funds are), you're engaging in the riskiest form of speculation. New money is nervous money, and there's a lot of new money is commodities right now.
 
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