O Canada! Currency Update, Eh?

In my November 6th post ("Obama Rally and Market Strategy"), I concluded with the following:

I'm also keeping an eye on the currencies. I sold our yen exposure back on the 24th when it spiked, leaving us with exposure to only the Chinese renminbi. I should have rolled the Yen exposure into the Canadian dollar at the time, but I missed it. The long-term fundamentals of the U.S. do not support its recent strength. The strong move in the dollar has been largely due to short-term technical reasons as well as a knee-jerk flight-to-safety. I am very negative on the dollar (long-term) at these levels and will likely be buying the Canadian dollar if it weakens much further.

Since early December, the long-term fundamentals of the dollar have once again been catching up with it. The chart above shows the dollar's performance relative to a basket of currencies that include the euro, yen, pound, Canadian dollar, Swedish krona, and Swiss franc. The dollar experienced a strong rally beginning in mid-July, as a flight to "quality" swept the globe. Since early December, the dollar has given up a good portion of its gains. The Canadian dollar, however, has not been a beneficiary so far and is actually slightly lower over this period. I don't expect this situation to persist over time. Just prior to the Fed's latest rate cut, I finally initiated a long position in the Canadian dollar.

The weakness in the Canadian dollar can largely be attributed to two factors: political turmoil and the country's heavy reliance on the natural resource industry. Canada's Prime Minister recently suspended Parliament until January 26th in an effort to forestall a bid by the opposition to oust him. The markets don't much care for uncertainty, so the loonie (the nickname given to the Canadian one dollar coin) has come back under pressure. I don't know how long this political turmoil will persist, but in time it is certain to pass, and the political uncertainty discount currently being pinned to the loonie will evaporate.

The other burden impacting the loonie is Canada's heavy exposure to free-falling commodity prices. Although beer, hockey equipment, and cross-border pharmaceutical sales may be sustained, they won't be able to offset the weakness from the country's natural resource sector. Canada will certainly be impacted near-term by the dramatic fall in natural resource prices, but those lower prices are already leading to less exploration and development and are sowing the seeds of the next commodity bull market.

Not surprisingly, Canada's economy has been weakening, but its problems seem almost quaint in comparison to ours. Until just the past few months, Canada had run a budget surplus for 8 years and even managed to pay down some of its national debt -- a debt that stands at roughly 32% of GDP versus a level close to 75% for the U.S. Canada's economy is only 10% the size of ours. While we're likely to run a deficit in 2009 somewhere in the $1 trillion range, the liberals and conservatives in Canada have been busy bickering over whether to run a deficit of $10-20 billion (we just "gave" that much to GM and Chrysler). While we're launching a full-scale offensive on our dollar, the Canadians are having a playful pillow fight with theirs.

Put simply, the fundamentals of Canada are more robust than those of the U.S. Political uncertainty will be resolved, and the foundation of the next bull commodity cycle is currently being established. In the meantime, some comfort can be taken in knowing that Canadian legislators (despite current politiking) are acting in a far more fiscally prudent manner than our government officials.

Our currency exposure now includes gold, the Chinese renminbi, and the Canadian dollar. We sold our yen exposure (FXY) back on October 24th at prices between $106-107. Although FXY has continued to move higher and currently stands at $111, we rolled our yen proceeds into Chinese stocks (FXI) on the same day at prices between $21-22, and that ETF now stands at $28.

The renminbi has been quiet this year, making it a strong outperformer relative to most assets. I continue to like this currency for the long-term given China's strong reserves position and, more importantly, the country's strong growth prospects in the coming years. My near-term expectations for the currency are very modest given conflicting pressure officials face to both lower and raise the exchange rate. However, the longer-term fundamentals of China and the current account imbalances that exist between China and much of the developed world will continue to exert upward pressure on the renminbi over time.

Finally, we've been long gold for some time, and I continue to feel very good about its prospects. Supply remains constrained while global fiat currency debasement accelerates. Were it not for mass forced de-leveraging, I suspect that gold would already be at new highs. We added to GDX in mid-October, and we recently added a new junior gold position. Gold has had a nice move of late, but each rally since September has subsequently failed. Gold is likely consolidating and moving into stronger longer-term hands. If so, at some point I would expect it to push through to new highs. In the meantime, I continue to opportunistically add to the metal and the mining equities on pullbacks.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Obama Rally and Market Strategy

Buy on the rumor, and sell on the news. The markets had a nice run-up of nearly 20% in the week prior to the election. This can't all be attributed to an expected Obama victory, but it was likely one of the factors.

Now, it's the morning after (well, the afternoon of the morning after the morning after), and it seems both Democrats and Republicans are selling shares once again. I'm guessing that Obama's supporters are selling some shares to replenish their cash after funding his campaign to the tune of $600 million (an absolutely insane figure). Republicans are likely terrified of the Democratic victory and are selling some shares to stock up on ammo and to reserve their "Palin 2012" commemorative moosehide parkas.

To what degree did an expected Obama win help boost stock prices just prior to the election? Of course, we can't quantify it precisely, but it may be instructive to look at the following graph of TAN, a solar ETF. This basket of solar stocks rallied about 75% in the week leading up to election day.


Obama has made no secret of his support for alternative energy development. In an October 31st interview with Wolf Blitzer of CNN, Obama listed energy independence as his number 2 priority for 2009 (the economy was number one). In that interview, Obama said, "We have to seize this moment, because it's not just an energy independence issue; it's also a national security issue, and it's a jobs issue. We can create 5 million new green energy jobs." The strong move in the alternative energy stocks leading up to the election hints of an expected Obama victory being one of the factors for the rally.

So, again we've had a rally, and again we're giving it back. There are plenty of potential explanations. Could be acceptance that analyst earnings estimates still have to come down. Perhaps the reality that our economic and financial problems transcend any President or government action is setting in. Maybe we're seeing profit-taking from the rally or more forced de-leveraging. Perhaps the Plunge Protection Team had to take a breather to reload the ink in its printing press.

Whatever the case, we should expect the dramatic volatility in the market over the past month to continue in the near-term. Fortunately, this volatility has provided some good trading opportunities. As I've stated, my intention has been to fade any strong moves in this market, and that's what I've been doing. Both times last month that the S&P 500 approached 850, I turned short-term bullish and added some long market exposure while covering my shorts. And both times the S&P 500 approached 1000, I sold those positions. The most recent assault on 1000 occurred on election day, during which I fortuitously unloaded the QLD, SSO, and GOOG exposure that had been added during the prior dip.

I was hoping to rebuild my short exposure gradually during the latest market rally. Unfortunately, I was only able to add a few short positions (a couple of alternative energy names and one financial) before the rally fizzled.

As we stand now, I plan to continue fading strong moves in the market. I'll be looking to cover the current shorts and rebuild the long side should we head back to recent lows. If we turn around and start heading back up, I anticipate adding short exposure in the S&P 500 and the Russell 2000 as well as in the consumer, alternative energy, and financial spaces.

I'm also keeping an eye on the currencies. I sold our Yen exposure back on the 24th when it spiked, leaving us with exposure to only the Chinese Renminbi. I should have rolled the Yen exposure into the Canadian dollar at the time, but I missed it. The long-term fundamentals of the U.S. do not support its recent strength. The strong move in the dollar has been largely due to short-term technical reasons as well as a knee-jerk flight-to-safety. I am very negative on the dollar (long-term) at these levels and will likely be buying the Canadian dollar if it weakens much further.

Disclosure: The Rubbernecker is long volatility and short whiplash.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Government Revenue Creep

I concluded my November 25th post ("Who Doesn't Enjoy A Good Spending Spree?") with the following comment: "This has been the enduring failure of Keynesian economics. Everyone loves a good spending spree. No one ever wants to take away the punch bowl."

The following graph (courtesy of Greg Mankiw) does a wonderful job of illustrating this. The rapid increase in government revenue relative to GDP in the early 1940's was due to World War II. The more interesting observation, though, is that this temporary increase in the size and scope of government was never reined in following the war. Instead, the government's share of economic activity has continued to grow over the past 60 years.



It would be naive to think that our government will ever proactively address the growing deficit and debt (on and off balance sheet) problem that we face. As has typically been the case, our leaders won't act until forced to, at which time we may be faced with a serious decline in the value of the dollar and/or the arrival of hyperinflation. Some combination of less government expenditure, higher taxes, lower entitlement spending, higher inflation, reduced entitlement benefits, and a weaker dollar are what ultimately await us. What we don't know are the exact contents of this poisonous cocktail or the timing of its arrival.

As for the investment ramifications of this, I would expect dollar weakness and gold strength. Assuming reasonable global growth, I would expect many commodities to perform well, and select international equity markets with better growth prospects and better fiscal restraint should handily outperform the U.S. (assuming reasonable valuation). Much of the U.S. fixed income market would be destroyed, although TIPS would certainly benefit.

Not coincidentally, many of our core long-term positions would benefit from such a scenario. Also consistent with this thesis, I recently added a long Canadian dollar and short U.S. Treasury (20+years) position. I'll spend a little more time on each of these later this week.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.