Dawn Bennett, Host of Radio Show "Financial Myth Busting," Interviews Axel Merkm, President and Chief Investment Officer of Merk Investments
Washington, DC -- (ReleaseWire) -- 04/25/2016 --DAWN BENNETT: Axel Merk is the President and Chief Investment Officer of Merk Investments. Axel is also the author of the book Sustainable Wealth, Achieve Financial Security in a Volatile World of Debt and Consumption. This book describes how the greater economic universe works, how it might affect your finances and how to manage those finances to seek financial stability. On March 16th, 2016, Merk wrote an article regarding the U.S. dollar's outlook which asks the questions to all of us: is the dollar's seemingly relentless rise in recent years coming to an end, which is the question I want to ask right now. Axel. welcome to Financial Myth Busting.
AXEL MERK: Great to be with you.
BENNETT: One of the most surprising market developments of 2016 has been the obliteration of those who had taken part in the biggest consensus trade in 2015, namely going long the U.S. dollar. The thing I find most fascinating is that the U.S. dollar selling is primarily taking place during local New York trading hours. Why do you think that is?
MERK: We watch currency markets quite extensively, and just like any other market, things are not always the way you expect them to be. A company has good earnings, and guess what? The company sells off or rises. And there is this perception that the dollar is supposed to be doing well when there's a crisis. The markets are falling, there is this "flight to quality," and this was ingrained in 2008, because the dollar was pretty much a misperforming currency; the yen did a little bit better. And what had happened is that the dollar was rising now, together with the equity markets, until last summer, and that's not supposed to be happening. And so similarly now, early in this year, when the markets were in turmoil and we realized that China is not going to grow as much as it would in the past, suddenly the S&P was falling and the dollar was falling as well. And it's changed a little bit in recent weeks, but generally speaking, the dollar has been falling when equity markets have been falling.
BENNETT: We live in a crazy world where the dollar has been on a tear, pretty much, in 2015, largely due to the fact that the Fed is merely going to slow down its accommodative monetary policy. Yellen finally built up the courage to raise rates a quarter of a point, and then ran scared and stopped there. What do you think would happen if we returned to the 5 percent or 6 percent interest rate that had been somewhat average throughout the history?
MERK: Well, it's not going to happen; not any time soon, anyway. But let's first talk about the first thing here. One of the key reasons the dollar had been rising is because we've been told for years, literally, that rates in the US are going to go up, and they can go nothing but up. And in the rest of the world, by the way, they can go nothing but down. But guess what? Mr Draghi, the head of the European Central Bank, recently said that we might've reached the bottom of the interest rate cycle, and Madame Yellen, the Fed chairwoman, has said that, 'Oh, maybe we're not going to tighten quite as much, and maybe we have to be worried about tightening financial conditions around the world.' Well, last time I checked, the whole point of raising interest rates is to tighten financial conditions. But somewhere she doesn't want to have it. She wants to go back to what you're saying, 5 percent, but we can't do that; we have too much leverage in the system. I sometimes say that the worst thing that could happen for the Japanese is that they get economic growth, because then rates would go up, and they would go bust, because they can't afford their deficits anymore. The same would happen to us. We can't afford our entitlements and all that if rates would go back to 5 percent; for a year or two, maybe, but not for an extended period.
BENNETT: Speaking of Yellen, she also likes to tell us that the global economy is creating a lot of headwinds, as economies are stalling in both the developed and the developing world. Presumably, the U.S. benefits as the dollar is rewarded, as investors seek to flight to quality. But why is the dollar always the beneficiary? Are there any other currencies out there that could be better than the massively overproduced dollar, at this stage?
MERK: Well, first of all, the headwinds we have because we built this recovery on asset price inflation, so the easy money of the Fed and other central banks inflated asset prices. And if we move away from that, asset prices are likely to deflate as volatility comes back. We had this environment for years, where complacency was fostered by central banks. And so that's really the big head wind that we have, and why the Fed is kind of tied up. Now, whether the dollar, or any strong currency's good or bad is really in the eye of the beholder. But if you have a lot of debt, then you want a weak currency, if it's domestically denominated, anyway. If you want to export a lot, you want to also have a weak currency. Now, for the U.S., the U.S. historically has been more ambivalent than some other countries, because only about 15 percent of GDP goes to exports in the U.S. A country like Germany has a huge percentage, so they have a much bigger interest in a weaker currency. But ultimately, if you have a weak currency, you're selling out to foreigners; I mean, you're becoming take-over targets. You really want to have a strong currency, in order to acquire things abroad, to invest abroad, but if you want to make your next quarter's earnings look good, you want to have a weak currency, and that's why many politicians and many companies say, 'Hey, let's have a weak currency, because then we live for another day.' And if I could just add to that, in Europe, Mr Draghi wanted to have a weak euro to help exports in Italy, Spain, and so forth. But guess what? The only folks that benefited were the Germans, because they already know how to export. And sure, you can export some tourism in Southern Europe, but you can't just switch everything that you do and suddenly start exporting, because your currency's weak for a month.
BENNETT: You've written about the dollar's habit of tracking U.S. equity markets, which isn't a typical thing currencies do. Why is the dollar different than others, and what does that mean for the dollar, if we're entering a major bear market territory in the months ahead, as many of us think we are?
MERK: Well, one of the reasons I put this food for thought out there that the dollar might weaken together with the equity market is precisely because I'm quite negative on the equity markets. I believe the bull market is very long in the tooth. And as the Fed is trying to move towards negatives—and I'm not suggesting that they will, and they'll go much higher, but just that action is going to get fear back into the market, just as it did earlier this year, and then what? The problem is "everything has been rising in value", and then so "everything is going to go down," and you may want to hide somewhere. Now, is the dollar special? Well, the dollar is special in the sense that many other countries, especially emerging markets, issue their debt in U.S. dollars; not exclusively, but quite extensively. And so when the dollar gets stronger, the obligations of those countries get stronger, and we tend to have an Asian currency crisis, or some other emerging market crisis, because suddenly it is too expensive for them to service their debt. And so with that, what the U.S. Federal Reserve does has ripple effects. Janet Yellen, the other day, gave a press conference, or gave a speech, where they said that, 'We now have to worry about the Chinese. We have to worry about this and that. I mean, we don't only have the inflation and the employment mandate and financial stability mandate; we now have to worry about China, we have to worry about equity prices. We've got to worry about everything,' and everything is in the hands of Janet Yellen, so we all have to wish that she has a long and healthy life, so that she can rescue the world.
BENNETT: (Laughs) You know, this actually brings me to an interesting historical point. My understanding is, historically, that the second quarter of a presidential election year typically is the worst average historical return of the four-year presidential cycle. So if the historic tendency holds true, the wind may be slightly in the face of stock investors over the next three months. What does that mean for the U.S. dollar?
MERK: Well, my guess is that it's not going to be good news for the dollar. And also just historically speaking, the dollar tends to do well in the anticipation of a rate hike; when it actually happens, it often weakens. And that's exactly, I think, what we see play out here. In this case, we're a little further into the game, because we've been told for such a long time that rates are going to go up, because at some point, you're going to start shifting again towards the next thing; you know, when are we reaching the top of that cycle? And then obviously it's always in the context of what everybody else is doing. To just give an example how absurd the situation is, in Sweden, for example, you have very low unemployment, you have very good GDP growth; it's just inflation happens to be low, mostly because of low energy prices, and they're paranoid that the Swedish kroner would get too strong—mostly notably versus the Euro—and so they have deeply negative rates. It's just unsustainable. And so they have to do a U-turn on their policy, and just as the U.S. is topping out. And so while we've been told forever now that the U.S. is great, everything is perfect in the U.S. and everything is horrible in the rest of the world, the real world is more greyish, and when prices get out of hand, we have some adjustments. And so of course as rates go up, you have other things that happen. For example, share re-purchases become less attractive. Suddenly the cost of labor gets a little bit higher. It might be good for real wages, but for profitability, it's bad when wages go up. And so there's another head wind, potentially, to stocks. And so, in my view, you can look at whether the glass is half-full or half-empty; you'll always find somebody who says the stock's going to go up. But we have had so many people that bought the dips over time that now we see change in sentiment, that people want to preserve the money that they've had. It's not something that's happening from one day to another, but I believe the rally we've had in recent weeks is just part of a bear market rally, and when it pans out, I think we've reached the highs in the S&P last summer, and we have a bear market that is yet to play out.
BENNETT: Gold this year is on a tear, and I'm wondering, what's your forecast for the remainder of 2016? Is this the bull market many have forecasted for the last couple of years?
MERK: Yeah, well, if we wait long enough, we'll find a bull market in the end. But the reason we like gold is two-fold. The first and maybe most important one, it historically has a very low correlation to equities and many other assets. And in a world where "everything has gone up," that's the sort of thing you want to look for. If you go beyond gold, you've got to look for some more exotic things. I mean, we do long, short currency strategies; well, that's great, except people don't understand it. Long, short equity strategies; I mean, how many individuals will pursue that? Gold is just an easy thing to wrap one's head around. Now, as far as the value proposition is concerned, we see, with the talk at the Fed and around the world, that real interest rates are close to zero, or even negative. Real interest rates are interest rates net of inflation. Well, gold doesn't pay any interest, so zero interest is better than a negative interest rate. And so the real competitor to gold, in my view, is if we were to get a real rate of return on cash. We had that with Walker in the early '80s, and clearly that period wasn't very good for gold. I don't see how we're going to have, even a decade from now, positive real interest rates, given the sort of entitlement promises we've made. And so, from that point of view, I see gold as kind of the core to diversifying a portfolio; it's just an easy one. Obviously, everybody has to make up their own mind on whether it's appropriate for them, but gold is kind of an easy answer to many of the things that are out there. It doesn't mean, of course, that the price of gold can't go down.
BENNETT: One of the knocks on gold from the Wall Street crowd is that it's a highly volatile asset, but in a recent piece you wrote, which is titled "Gold Now," you said it's actually the opposite, that gold is one of the most stable commodities. So where did this myth come from?
MERK: Well, it kind of depends on what you look at. If you look at just the typical volatility of gold, it's comparable to that of equity markets. The other commodities are much more volatile, and in fact, other commodities have much more industrial influence. And so as we've had commodities plunge down, gold has held up much better, because it doesn't have that industrial use, and it's kind of more as monetary item. Now, if we have a huge surge in commodities, odds are that gold is going to lag in that process, so there it's less volatile than those sort of commodities. The question is always what sort of risk profile do you want to have? And to me, gold is kind of plenty volatile, from that point of view, and it's difficult to find an uncorrelated asset that's less volatile; bonds might qualify, but at the same time, I wouldn't want to touch many bonds with a broomstick. But they have worked out for many people, and good for them. I prefer gold over bonds, in many situations.
BENNETT: In February you advised investors to use any short-term rallies to diversify out of equities and to include gold; is that still what you're telling your clients?
MERK: It applies to clients that are over-exposed to equities, which I think most clients might be. During the good times, people bought equities; they didn't rebalance. And if they haven't done it, it's high time that they do it, and gold is one of the things they can consider.
BENNETT: Gold, so far, is up 16 percent in the first quarter of 2016. What are you projecting, if you can, for the rest of the year?
MERK: We try to not get into the guessing game, because the moment you reach your price target, you're just going to revise it. You're going to say, 'Gold is going to go up 10%,' and when it goes up 10%, then you say, 'It's going to go up another 10%.' Gold is one of those things that can take on dynamics of its own. And what we have seen is that the interest is broadening. The long term holders were in gold, and as of the beginning of the year, you have folks that are interested in technicals go in, you have some momentum players go in, and so it's broadening the interest, it's broadening the volume. That changes the dynamics, but as we all know—and that's where the volatility comes in—it can shoot up if suddenly everybody piles into it, and then any price target you make has to be revised. To me, what's relevant is that the fundamentals, in my view, are appropriate for gold at this stage. And by the way, gold doesn't change; it's the environment around it that changes. And so when it comes down, I consider adding some, and in the meantime, I'm enjoying the ride, and I'm glad I have some gold, while others are invested in equities that, in my view, are over-valued right now.
BENNETT: We have less than a minute left, Axel. Speak of the volatility that gold has had for the last three to four years.
MERK: Well, it had come down steadily, the prices, and the volatility actually wasn't so huge most of the time. You've really got to look at gold over the very long time, because just like any other asset, volatility can be very tight, and then suddenly something comes to brace that out. If you want to make a decent allocation to your portfolio, the question is always can you sleep with that allocation at night? I'm not suggesting you have a gold bar under your pillow, but can you stomach volatility that might come about? And so that's really the limit of how much gold one should have. And yes, it can move a couple of percentage points in a day quite easily.
BENNETT: Axel Merk, thank you so much for being on Financial Myth Busting.
For over a quarter century, Dawn Bennett has been successfully guiding clients through the complexities of wealth management. Dawn Bennett provides individual investors, corporations and foundations with holistic investment strategies. Her unique vision and insight into market trends makes Bennett a much sought after expert resource with regular appearances on Fox News Channel, CNBC, Bloomberg TV, and MSNBC as well as being featured in Business Week, Fortune, The NY Times, The NY Sun, Washington Business Journal in addition to her highly regarded weekly talk radio program - Financial Mythbusting. Through prudent and thoughtful advice, Dawn Bennett has strived to consistently provide the highest quality of guidance.
About Dawn Bennett
Dawn Bennett is CEO and Founder of Bennett Group Financial Services. She hosts a national radio program called Financial Myth Busting http://www.financialmythbusting.com.
She discusses educational topics and events in the financial news, along with her thoughts on the economy, financial markets, investments, and more with her live guests, who have included rock legend Ted Nugent, as well as Steve Forbes and Grover Norquist. Listeners can call 855-884-DAWN a as well as take podcasts on the road and forums for interaction.
She can be reached on Twitter @DawnBennettFMB or on Facebook Financial Myth Busting with Dawn Bennett.
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