Commodity Appreciation and/or Dollar Devaluation

–A cup of coffee at the Grocery Bar on Fitzroy Street now costs $4.20. And you thought the Dow Jones making its first post-Lehman Brothers collapse high was today’s big news. Not! It’s all about the coffee.

–Well, not just the coffee. The gold. The oil. The silver. The noble metals. The base metals. Pretty much anything that is priced in U.S. dollars is reacting to yesterday’s announcement by the Federal Reserve that it would print money/devalue the dollar.

–What dollar devaluation means to you depends on where you are reading this e-mail and the colour of the money in your wallet. If your money is green, gold, blue, red, and pink, then you’re loving U.S. dollar devaluation. Your trips to America are getting cheaper by the day. But what about your investments?

–For Aussie investors, the dollar devaluation has generated a massive speculative trade. Higher commodity prices could have an immediate effect on the profitability of certain commodity producers. Investors are bidding up the value of those producers and gaining some exposure to the underlying commodities.

–Our mate Alex at Diggers and Drillers reckons copper shares are the best way to speculate on the whole situation. Alex might not call it speculation, but he’s not here! He’s on a plane to Africa to do another site visit at one of the copper companies he’s recommended. This is all part of the ‘Kalahari Carve Up’ story.

–If Alex WERE here he’d probably nod with approval at this Bloomberg story. The story repeats the basic contention Alex has made for the last four or five months: that copper is entering a supply deficit as demand inexorably grows. Analysts at Standard Chartered Bank reckon the price of a tonne of copper could hit US$12,000 in the next few years—a 41% increase from recent levels around $8,499.

–Copper is still off its July 2008 high of $8,940 a metric tonne. But if Alex is right and there is a real structural deficit in the copper market (evidenced by very tight stockpiles at the London metals exchange), it will take out that old high in short order. And when you add the ‘torrent of cash’ coming from the Federal Reserve, the price of tangible goods relative to the dollar rising more or less across the board.

–Based on our experience in 2008 (which was bad) we regard the repetition of chronic supply shortages in the commodities sector with a lot of suspicion. However, something must be driving higher commodity prices. It’s either the deliberate devaluation of the U.S. dollar or some favourable dynamics in individual commodity markets.

–It’s possible that it’s some combination of both. But it’s our view that the dollar devaluation effectively makes all commodity investments (and therefore most Aussie share market investments) a huge speculative punt on the weaker dollar. So is it a punt you should make?

–As our other mate Kris Sayce pointed out this morning, if you’re a punter, how can you not have a crack? When we spoke this morning, the futures markets already indicated that the market would open one and half percent higher. If you’re a speculator, the ‘torrent’ of liquidity in the markets is almost inevitably bound for resources and resource equities. You may even be able to make gains faster than the Fed can devalue the dollar—at least if you’re an Aussie investor.

–The chart below shows what a giant fake-out move nominal highs are for U.S. indexes though. In a nutshell it shows that U.S. financial assets might be going up in nominal terms. But the devaluation of the U.S. dollar means that relative to virtually everything else, U.S. financial assets are losing value. The chart specifically shows the nominal performance of the Dow Jones Industrials Average over the last ten years (the red line) and the price performance of the Dow (blue line) and of gold (red line).

Nominal Highs on the Dow Conceal Dollar Devaluation

–This is an important point because it means the message that new stock market highs normally communicate to you—that business is improving and corporate earnings are great and the economy is growing—is a false message when it’s influenced by Fed money printing. The Fed has created a cottage industry of speculation on financial asset prices with its policy.

–In other words, indexes can make new highs in U.S. dollar terms, but for anyone else who has t convert those gains back into a foreign currency, the falling value of the dollar will wipe out your real return. As usual, the Fed’s policy is about one thing and one thing only: supporting U.S. banks with a low cost of capital and gently eroding away the cost of paying back U.S. debt.

–Investors like this kind of dollar devaluation to the extent that it creates speculative opportunities in commodity related equities. Alex and Kris seem to love it too. It’s a real opportunity for punters and speculators to make money.

–But what you’re seeing is the accelerated breakdown of the world’s reserve currency. This is going to create tremendous upward pressure on food and fuel prices all over the world. Those price increases will not be politically sustainable. And when that level is reached, something is going to break. It will probably be the dollar itself. And that is going to unleash a great deal of uncertainty. For now, though, everything’s looking green. Enjoy your $4 coffee. It could be $6 sooner than you think.

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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where is the chart?

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