Which currency is best - the euro, dollar or sterling?
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Dominic Frisby Jun 09, 2010
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With stocks tanking, you might well be tempted to get out of the market, if you haven't already. I wouldn't blame you.
But while it's all very well recommending readers to go to cash, the problem for some time now has been this – which currency? Sterling, as we know, has been hit hard in the forex markets, and holding euros in 2010 would have been an awful strategy.
Much of the problem lies in the fact that no government at present wants a strong currency. No wonder. A weaker currency potentially boosts exports and devalues debt.
So today I want to take a look at the pound, the euro and the US dollar and consider, as the carnage continues in the stock markets, where's the best place to hide...
Will the dollar rise to five-year highs soon?
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Despite fiscal indiscipline running rampant through the US establishment, the US dollar has had a terrific year. It benefited first from the crash – I think we can call it that – in the euro, and also from the fall in sterling. It has also benefited from the dramatic falls in Western stock markets which began in late April, as the world began liquidating positions and going to cash.
I turned bullish on the US dollar last November, when I posted the chart below. It shows the US dollar index, which measures the US dollar against a basket of currencies. And I'm very pleased with this call.
I had no idea, however, that the dollar would rise with such force. In just over six months, it has gone from 75 on the index to 88.5 at the close yesterday.
I would have thought there might be quite a lot of resistance in the 88-90 area. So this near-parabolic rally could at least stall. However, this rout in stock markets seems to be far from over, and the longer it continues, the longer the dollar will benefit. More carnage over the next fortnight could see the dollar rise potentially to five-year highs.
This dollar rally has nothing to do with US government and Federal Reserve policy, by the way. The US constantly moans about China's 'artificial' dollar peg, which makes US exports uncompetitive. And US Treasury Secretary Tim Geithner argued at the recent G20 summit that government spending (and by extension printing money) is the route out of all this.
So it's fair to conclude that US policy-makers want a weaker dollar. Instead, the dollar's rise has been due to greater problems elsewhere, and its status as the senior global currency.
Given everything, I would have to say I am neutral about the US dollar at present, or neutral to bullish. I own a few. I'm not selling any. But nor am I buying any more. It's a hold.
What about the euro?
The euro, which is basically in freefall, is also reaching a potential line of support, as this next chart of the euro versus the dollar shows.
I should say here, that if I'd drawn that chart a month ago, I would have bet on the euro finding support at $1.25. But in fact, it just busted through that level.
It could find some support at just below $1.20, but the force of this downmove is astonishing. My instinct tells me that eventually we are going to parity with the US dollar – possibly even to $0.90. The question is, how fast?
Overall, I am neutral-to-bearish on the euro here. I am certainly not buying any – I'd need to see much greater evidence of a bottom first – but nor am I selling. The great opportunity for that was late last year.
Could sterling surprise us all?
This may surprise some of you, but I am not as bearish on sterling as I once was. Of course, we will continue to see the purchasing power of all currencies decline. That's the nature of modern fiat money. But relative to other currencies, the worst of the falls may be over for sterling. Why do I say that?
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First, there is evidence of fiscal sanity returning to government. David Cameron this week said, "You have to address the massive welfare bills. You have to address public sector pay bills. You have to address the size of the bureaucracy that has built up over the past decade… We need to address the areas where we have been living beyond our means."
This is a sign that once out-of-control deficit spending will be reined in. That has to be bullish for sterling. The danger is that the government, despite its best intentions, does not have the strength of a large majority and is thus vulnerable.
But other promising signals are coming from Britain's central bankers. Charles Bean, deputy governor of the Bank of England, wrote last week in The Telegraph that "no one should fool themselves into believing that Britain can inflate its way out of its public debt mountain."
He continued: "Some people have suggested that a bit of extra inflation now might actually be a good thing. After all, wouldn't it help to get the economy going by reducing the real value of public and private debt?
"This is severely misguided. Aside from the dubious morality of redistributing wealth from savers to borrowers, we have seen from past experience that a bit of inflation has a nasty habit of turning into a lot of inflation."
There is no guarantee of course that the BoE will do as Bean says, but it is nonetheless another sign of fiscal tightening which has to be bullish for sterling. Those who are waiting for nominal house price falls may get them after all (In real money, British house prices are down by 70%).
Sterling might decline to just below the $1.40 level (it currently sits at around $1.45). But I would expect that $1.38-$1.40 level to hold. It has proved a major support over the last 20 years. Indeed it has only broken below that level once – in 1985 – when sterling went briefly to $1.05.
But if $1.38 doesn't hold and we break below then, like the euro, we could easily fall to dollar parity before you know it.
So, as far as the pound goes, I'm waiting and watching. But going long the pound at $1.38-40, should it get there, with a stop at say $1.36, just below the old lows, does not seem a bad bet to me.
I'm sure the overall currency picture, and any changes in trend, will be a lot clearer by the end of the month.
Finally, many of you who were active amongst the London junior mining investment community will have known Ashley James. On Monday night, he sadly died after a heart attack. Ashley was unforgettable, a true eccentric, both fiery and knowledgeable. We have lost one of our great characters and he will be sadly missed. My thoughts – and I'm sure those of all who knew him – are with his family at this time.
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