Peter J. Cooper’s Weblog

August 28, 2008

UAE revaluation off the agenda but how safe is the dollar?

Filed under: Gold & Silver, Inflation, US Dollar — peterjcooper @ 9:57 am

The upturn in the fortunes of the US dollar over the summer months has really put an end to talk about revaluation of the dirham which raged earlier this year until the government made a definitive statement saying it was not going to happen. But what is far more open to question this autumn is the fate of the US dollar and via the peg, therefore the outlook for the UAE currency.

Will the US dollar rally prove to be a short-term bear market rally, or turn out to be something more durable? It is certainly a major consideration in an export dependent economy like the UAE, and effects major sectors of the domestic economy as well, from tourism to real estate.

The precise reason for the recent dollar rally seems to come down mainly to massive market intervention, particularly during the August Olympics. The Chinese have been buyers of dollars to keep their exports competitive at a time when the economy is slowing down, something reflected in the recent 50 per cent crash in their stock market.

The European Central Bank appears to have been a seller due to concerns about the impact of the overvalued euro, and there has been little support for sterling against the dollar. However, the problem with coordinated market interventions – for that is what this seems to be – is that they generally fail in the long term.

A market intervention is like feeding drugs to an addict. They need more and more until the drug has no effect or leaves them unconscious. Remember, for example, the many attempts to stop the devaluation of sterling in the past century. All of them ultimately failed.

So how long can the dollar defy gravity? It might make it to the US presidential election. A stock market crash – as investors take onboard bank failures and a poor profit outlook – could actually rally the dollar a little longer, as liquidating portfolios would actually boost demand for cash, for a while.

But the unbelievable size of US indebtedness, and the size of the bail outs likely to be required for the banking system, suggest that the US dollar does indeed have substantially further to fall in the near term. As this column has argued in the past a $2 euro can be expected as the US printing presses roll to bail out the banks, and a hundred or more could fail compared with nine thus far.

So should UAE residents and investors see any strength in the dollar as a chance to exit this autumn? The problem is that we seem to be moving into an era of competitive devaluations.

For example, if you had bought sterling for its high interest rate two months ago then you would be sitting on a 7.5 per cent capital loss against a three per cent gain in annual interest compared with holding dirhams or dollars. Any sterling asset, such as a house, would also be showing the same loss in dollar terms.

My personal view is that in these circumstances gold, and also silver, should be regarded as currencies of choice. Most pertinently because of their relatively fixed supply, which becomes especially significant when the printing presses are rolling, albeit metaphorically as most of the new money will be issued in US treasury bonds.

Again life is never that easy as precious metals also took a hit over the summer as the massive currency interventions caught the market off guard in thin summer trading. But that does surely leave gold and particularly silver at exceptionally attractive levels.

On the other hand, the lesson of this summer for investors was surely that diversification remains the best way to stabilize returns. Gold investors with large US assets, for instance, could balance the gain in one class against losses in the other. Keeping a spread of assets - both correlated and non-correlated, does make considerable good sense in such a volatile environment.

That might also include the UAE dirham. At present it appears that nothing much is likely to happen before the GCC monetary union in 2010, and what happens then will fall short of a full union. But there is a lot of time before 2010, and one has to wonder how the UAE authorities would respond to another big devaluation in the US dollar.

It could still be that the UAE dirham proves a better place to hold cash, if a revaluation were to suddenly come back onto the agenda. There is, after all, no advantage to holding dollars in terms of the interest rate, and a possible revaluation comes at no additional charge to the account holder.

To conclude, I do not envy treasury managers this autumn as currencies could swing violently and be subject to unpredictable market interventions of a somewhat competitive nature. And in this environment an above average exposure to precious metals looks advisable, although the dollar may hold up for a while.
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June 18, 2008

Dubai house prices up 78%, another surge guaranteed

Filed under: Dubai Property, Inflation, Oil Prices, UAE Stocks — peterjcooper @ 10:34 am

Dubai house prices rose 78 per cent in the year to the end of Q1, according to a report from Colliers International. But all the anecdotal evidence suggests that rising prices have continued since then, and may have considerably further to go as the Federal Reserve cuts interest rates again this autumn.

The UAE currency peg to the US dollar means that the interest rate cuts to two per cent this year have been matched locally, despite the economy being in an oil boom rather than an economic slump. Local mortgage rates on four-year fixed rates have fallen as low as 5.3 per cent.

Falling interest rates mean that local bank deposits earn around one per cent while rental yields in Dubai range from five to seven per cent. Landlords can still buy-to-let and cover their mortgage costs, although less than 25 per cent of freehold properties are actually under a mortgage.

Now a 78 per cent price gain in a year is going some. But this momentum towards higher prices will continue until something happens to slam on the brakes. In fact, the likelihood is that the Fed will put its foot down on the accelerator at least one more time, probably this autumn, and cut interest rates again.

Today the second largest bank in the UK, Royal Bank of Scotland has informed its clients that it expects a credit and stock market crash within three months. If this happens the Fed will inevitably respond with a further cut in interest rates from two to one per cent.

That will mean the cost of servicing a Dubai mortgage will fall immediately by up to 20 per cent. The local stock markets will take a tumble with global markets as we saw last February. And with nowhere else to go local investors will pile into property as they did after the UAE stock market crash in 2006.

After that how much longer the Dubai real estate boom will last is probably dependent on a time-lagged response to falling global oil prices, and surely oil prices will drop sharply in response to a global credit and stock market crash. Dubai house prices are going to be very much a side-show to the main event which will be salvaging the global economy and preventing a recession turning into a depression.

Hence low interest rates are likely to persist for quite some time and dampening Dubai house price inflation is probably not going to figure highly on the list of macroeconomic priorities.

Reason then to predict that the 78 per cent price hike seen in the year to the end of the first quarter is not the final call in this house price boom. It could well run until the Federal Reserve tightens interest rates, and that may well be years and not months away.
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Gold and silver prices to rocket as inflation grows this summer

Filed under: Gold & Silver, Inflation, Oil Prices — peterjcooper @ 7:01 am

Inflation is all around us these days, whether buying food, petrol or searching for new accommodation. Interest rates are negative, and no government seems serious about putting rates up as the global economy slows. In this environment only one financial investment class is guaranteed to shine, and that is precious metals.

Unless you seriously believe that the US dollar is about to stage a spontaneous recovery with Fed interest rates at two per cent, then stocking up on gold and silver this summer while prices remain low after the March hiatus, makes excellent sense.

Over the past week precious metals have taken a hit after remarks from Fed chairman Ben Bernanke that he is turning hawkish on inflation. But there is no action to back up this rhetoric in the markets. Do not hold your breath for a rate rise on August 4th. It is not coming anytime soon.

Lest we forget: US unemployment rose 0.5 per cent last month; US home sales and house prices are in free fall, and not expected to bottom for 18 months; high energy prices are dampening consumer spending and axing confidence levels. If Bernanke raised interest rates in this environment Americans would send out a lynching party. More seriously any increase in interest rates would crash the bond and stock markets.

Indeed, it is far more likely that the pressure will come in the other direction, either this autumn or early next year. Bond prices look expensive against surging inflation, while corporate profits are being squeezed by inflation threatening stock valuations. Both the stock and bond markets are set up for a crash, and that would mean lower and not higher interest rates.

Now if interest rates fall, say from the present two per cent to ‘an emergency’ one per cent, then the US dollar will take yet another tumble. Gold is inversely correlated to the greenback – so it will head in the opposite direction, and upwards in value. Silver is the precious sister of gold and will follow and perhaps out perform as it has historically.

There is a seasonal pattern to precious metal prices which has more to do with Indian festivals and their gold buying than the US dollar. That leaves prices weaker over the summer months with a tendency for a strong upward lift in September.

Last summer we saw gold prices trailing around the $650 an ounce mark, and then an autumn price surge from September that took prices to a peak of $1,030 by March. With prices hovering around $870 today that is still an advance of one third in price on a year ago. And with world inflation set on an upward march, and the US dollar poised for further weakness in the near future, the bull market for gold is far from finished.

Oil is far above its previous inflation adjusted, all-time high of 1980 and more than three times its nominal price level in 1980. If gold prices are inflated by the same factor as oil since 1980 then the price of gold is $3,100 per ounce.

Now that is not to say that gold prices are about to surge to $3,100, although in an inflationary environment anything is possible. But this does make predictions of $1,200 this autumn and much higher next year looks very reasonable as investors become increasingly desperate to find a hedge against uncontrolled inflation.

There will also be more and more money pursuing fewer and fewer solid investment opportunities. The global central banks are effectively printing money with low interest rates to offset the deflationary impact of falling house and other asset prices.

This new money searches for a home, and is not necessarily attracted to assets whose valuations and price levels look uncertain. The money will go where it is most likely to earn a return, and precious metals with their comparatively fixed supply will rise in value as the supply of paper money grows, creating a virtuous investment cycle.

But precious metals do not go up in a straight line. There is considerable volatility along the way. That is why buying cheaply during a temporary lull in metal prices is such a good idea. It worked last summer, why not this summer?

And do not get so mesmerized by gold that you forget about silver. In the late 1970s it was silver that delivered the biggest price rise of all when the Hunt brothers formed a pool with Middle Eastern partners to corner the market.

Only last week the Hunt family sold its privately owned Hunt Petroleum business for $4.2 billion leading to some speculation about how the family might decide to invest its new fortune. History does tend to repeat itself, and precisely the same arguments that first took the Hunts into the silver market at $3 an ounce in 1973 apply now. When their pool crashed in 1980 silver was $54 an ounce.

If silver is inflated by the same factor as oil since 1980 then the price is $194 per ounce, a considerable increase on under $17 today. And silver is the only commodity not to have passed its previous all-time high in the current commodities boom. Perhaps the Hunt family will prove once bitten and twice shy, but to invest in silver in present market conditions would appear shrewd.
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May 31, 2008

Memo to Hank Paulson on his visit to the UAE

Filed under: Inflation, Oil Prices, US Stocks — peterjcooper @ 8:33 am

US Treasury Secretary Hank Paulson arrives in the UAE today at the start of a tour of the Middle East. He is expected to reassure the government that investments from sovereign wealth funds are welcome and that the US dollar is coming off its lows.

Behind the scenes he could well be battling on two fronts: trying to secure additional oil supplies to keep the price of Black Gold down; and reassuring the government that a revaluation of the dirham is not required as the dollar is recovering.

The problem is that this is a case of the pot calling the kettle black. It is loose US monetary policy that is driving oil price inflation. US interest rates are being held below the level of inflation and this is pushing investment into an asset class that can hold its own against inflation: oil. This is a self-fulfilling investment cycle, and is a market phenomenon that has little to do with supply and demand.

It is the same loose monetary policy that is devaluing the US dollar to save the US financial sector from its bad lending practices, and pressuring the dirham downwards due to the fixed dollar-peg.

Now while it is possible that the US dollar could be short-term over-sold and due for a longer rally than the one seen over the past month, the longer term direction of the US currency is still down, with interest rates held low to support a flagging economy while the European Central Bank fights inflation alone. That will not sustain a dollar rally.

Ex-Goldman Sachs chief Paulson will need all his persuasive charm in the UAE capital to persuade leaders that black is white. The difficulty is that what is not true can not be re-stated as the truth. Fortunately for Paulson he has only another seven months in office and will not be there to be held accountable for what he says today. Heaven help President Obama!

But I suppose Middle East conspiracy theorists will also be working over time on this visit. Perhaps Paulson has a big strategy to get the world economy back on its feet by this autumn and needs the help of Abu Dhabi? The presidential election is a last stand for this generation of Republicans.
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May 9, 2008

Oil at $126, heading for $150-200?

Filed under: Gold & Silver, Inflation, Oil Prices, Uncategorized — peterjcooper @ 8:56 am

This week oil tripped past the $120 a barrel mark for the first time and touched $126. Yet it was only in January this year that we saw $100 oil for the first time. That barrier has been decisively breached, and perhaps for oil the only way is up with $150-200 within 18 months to two years being forecast by the experts at Goldman Sachs, not a firm to take lightly.

Billionaire hedge fund manager T. Boone Pickens can not have had a good start to 2008 as the oil price has refused to fall as he predicted and his funds are doubtless suffering as a consequence. Now the bulls are in control of the oil market, and the lack of additional physical supply in the market is adding fuel to this fire, and news of an emerging civil war in Lebanon is hardly going to help calm fears about Middle East instability.

But it could be the hedge fund managers who chose to enter the energy markets this year and place money on higher prices that are most to blame for $123 oil, and who will drive the price still higher. You still have to wonder though, where is all the money coming from that is flowing into oil and gas futures and other energy related derivatives.

The responsibility surely rests with the US Federal Reserve. The loosening of US monetary policy, with interest rates down to two per cent, is allowing hedge funds to take huge leveraged positions in the energy markets, and food and other commodities for that matter. This is the direct root cause of this inflation.

Former Fed chairman Paul Volcker was correct when he said in 2000: ‘Inflation is related to monetary policy. It’s related to the issue of money. The issue of money is a governmental responsibility predominantly, and to use that authority in a way that leads to inflation is a system that fools a lot of people, and to keep fooling them you have to do it more and more.’

Volcker after all was the man who beat the 1970s inflation in the early 1980s, albeit with monetary policy that produced a deep recession and the bankruptcy of thousands of local US saving and loans institutions.

But if we are really back to those bad old days of sky high energy prices and soaring inflation, and the Fed has indicated that it will do whatever is necessary to support the US economy, then the logical conclusion ought to be that $120 oil is just another step on the ride towards $200 or $300 oil, or whatever it takes to slow the world economy to lower consumption.

The fundamentals just do not look good for lower oil prices. One million more cars are bought by the Chinese every year, and energy consumption is on an uptrend worldwide. But the supply position is precarious with production falling in the North Sea fields and Russia, and new supplies insufficient to replace dwindling reserves.

Prices could go very much higher from here, albeit a seasonal summer dip in prices might still be expected. It may take a far deeper US slowdown with a global impact next year to really bring oil prices back to earth. Goldman Sach is probably right, and oil will take gold and silver up with it, along with food prices, and the consequent social unrest.
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May 1, 2008

Fed rate cuts cause global starvation

Filed under: Inflation, Media, US Stocks, Uncategorized — peterjcooper @ 7:47 am



Low interest rate policy is how the US defends its economy from an economic downturn. But this is also the cause of all recent major economic bubbles, or inflations. First came the dot-com stock market bubble; then the US and global house price bubble; now food and energy.

 

The Asian Development Bank says one billion people are going hungry because of recent food price inflation. That is the 600 million who live on less than one dollar a day, and 400 million who have only a little more. When you live on that budget, food is your main expense, and if food prices go up then you starve.

 

So the rich in the US are offloading their housing crisis on to the poorest of the world. Preventing a US recession is more important than the estimated 24,000 people who die of starvation every week.

 

More are going to die as a direct result of the Fed’s 0.5% cut in US discount rates to 2% last night. This is what feeds food inflation, lax monetary policy.

 

Inflation is, and always will be a monetary phenomenon. You can certainly point at underinvestment in global agriculture – mainly due to the subsidies given to farmers in rich countries – as a contributory factor to food shortages and food price inflation.

 

But it is not the core reason. We have had bad harvests and poor weather many times in the past without the price of staples like rice and wheat doubling in a year. It is the Fed’s policy of loose money to save the US economy from its overspending and over borrowing that is to blame.

 

Hedge funds and other speculators are siphoning this cheap cash into investments in food and energy and forcing prices up, and when they get on a trend they stick with it.

 

Would it now be better to raise interest rates and let the US economy collapse? No but something radical needs to be done to solve the world food crisis.

 

How about rebuilding Russian agriculture as a new bread basket for the world? It lags the US in productivity by 80 per cent and a massive investment in modern technology would produce a second green revolution. Arab investors should be looking at redirecting oil revenues into agricultural production, which will prove an excellent investment as well as a humanitarian act.

 

In the meantime, expect to see more social unrest as a result of food price rises. People just refuse to take starvation lying down, but few will understand the Fed is to blame.

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