The Dollar Is On The Hot Seat – The AIA Advocate Newsletter Week of 10/28/2010

In This Issue:

Earnings Continue To Impress Investors

A Second Stimulus Program Is Due To Begin

The Dollar Is On The Hot Seat

Many Investors Expect Rising Inflation

The Bottom Line

Stocks continued their happy advance during October. Since our last newsletter on September 29, the Dow and the Nasdaq rose 2.3% and 5.3% respectively. The uptrend may have enough support to continue through the holidays and send the New Year off to a good start. We have our fingers crossed.

Earnings Continue To Impress Investors

One reason that stocks are doing well is many companies are continuing to report better than expected earnings. About a third of the S&P companies have announced their third quarter results so far, and 83% of them topped the estimates. At this rate, earnings should be 28% higher than a year ago. That’s the sort of surprise that warms investors' hearts.

The financial services industry is continuing to lead the earnings race. Their gains aren’t quite as impressive as they may appear because the companies did poorly last year. Nevertheless, improving bank performance is a good indication that the global economy remains healthy.

A Second Stimulus Program Is Due To Begin

The Fed isn’t waiting for the global tide to lift U.S. growth off the floor. The agency is planning to pump as much as $500 billion into the economy to get it moving up again. This second quantitative easing program, known as QE2, is set to begin next week. The Fed hopes it will finish the work the first stimulus program started in late 2008.

Analysts are divided about how effective QE2 is likely to be, but most agree that it will help many businesses. However, the additional spending is unlikely to have much impact on the unemployment rate. Until jobs start to come back, the important consumer sector is likely to remain weak.

However, there are some encouraging indications that consumers may be somewhat better off than their current spending habits suggest. It appears that many people are clutching their pocketbooks tightly because they are nervous about the future, not because they don’t have money to spend. Top-selling products like smart phones and flat screen TVs show that funds are available when people find something they really want. Improving America's confidence about the economy may do more for the recovery than the Fed’s new stimulus program.

The holiday season should tell us more about the public mood. If cash registers ring more loudly than last year, 2011 will probably be a better year than analysts have been predicting.

The Dollar Is On The Hot Seat

One of the Fed’s goals for QE2 is to lower the value of the dollar. In fact, the greenback started to slide right after the stimulus program was announced in August. Since then it has dropped 6.6% against a basket of six foreign currencies.

At first glance a cheaper dollar would not appear to be helpful because it may contribute to inflation. However, during tough economic times a lower dollar can make American products less expensive overseas and boost our export business. That, in turn, will help our manufacturers and lower the balance of payments deficit. Since inflation is very low at present, the benefits of a lower dollar would seem to outweigh its disadvantages.

Of course, America's trading partners aren’t happy about seeing the dollar decline because it will make their products more expensive here. The countries with the most to lose are threatening to devalue their currencies to keep pace with the sinking greenback.

There is a chance that a currency war could break out during which countries devalue again and again to stay ahead of each other. Such a war would have dire consequences, which is why we think it will be averted. Twenty of the world’s leading countries are currently working on a solution to the problem.

Many Investors Expect Rising Inflation

Many investors fear that Washington has already dumped so much money into the economy that a period of rising inflation is baked into the cake. To protect themselves from a weaker dollar, people are buying precious metals, foreign currencies, and other traditional inflation hedges. In the few areas where real estate is starting to turn around, investors are also starting to buy rental housing.

Precious Metals

Gold and silver are in particular demand, and their prices have been soaring. Since January the two precious metals have gone up 20.7% and 37.2% respectively. Coin dealers report that they have not seen such a buying frenzy since the 1979-80 period when gold shot up from $36 an ounce to over $800.

Although we agree that higher inflation is likely, we think chasing after gold and silver right now is not a good idea. Investors should remember that shortly after gold soared past $800 in 1980, it fell 82% when people realized their inflation expectations were too high. Silver dropped 70% from $20.65 (the price without the Hunt brothers' manipulations) to $6.14 in 1985.

We don’t think precious metals are due for such a severe correction this time around. However, we do think investors might be smart to wait for prices to cool off before buying more gold and silver.

Foreign Currencies

If you wish to protect yourself against a weak dollar and rising inflation, we think strong foreign currencies will serve your purpose better than precious metals.

The currencies that appear to have the most potential are from countries with large supplies of valuable raw materials and commodities. Rampant buying from China and other developing nations is keeping natural resource prices high and, in turn, the currencies of their suppliers.

One nearby country with a strong resource currency is Canada. Their dollars have moved up strongly in recent months and are now almost at parity with U.S. dollars. There is a good chance they will move ahead of the greenback sometime next year.

Americans can easily open Canadian dollar accounts and CDs with EverBank World Markets (, 888-882-3837). Because EverBank is an American institution, its accounts and CDs are FDIC insured up to $250,000. Having foreign currency accounts in the U.S. also makes it unnecessary to register them with the IRS.

For a Canadian dollar position you can also buy the CurrencyShares Canadian Dollar Trust (FXC). This convenient ETF tracks our northern neighbor’s currency very closely.


As with strong foreign currencies, companies in the best position to benefit from inflation are raw material suppliers. In our opinion, the leader of that group is BHP Billiton (BHP), a company we first recommended in May 2006 when it was selling for $38.19. BHP is now trading for $82.19, a heartwarming 115.2% gain. The company currently plays a 2.20% dividend.

We think BHP still has a long way to go. The company is a leading source of a highly diversified group of essential industrial metals including aluminum, copper, lead, zinc, silver, nickel, titanium, and manganese. The company has customers throughout the world.

BHP is also a leading energy producer. The company supplies coal to power plants in Europe, Asia, and the U.S. In addition, the company produces natural gas in Australia, the U.K., Algeria, and several other countries. Lastly, BHP Billiton owns about 40% of the world's known uranium supplies.

Blue chip companies that do a great deal of business in the global economy are also good hedges against a weaker dollar and rising inflation. Because many of the profits such companies earn are denominated in foreign currencies, they are adjusted upwards for any drop in the dollar. For example, if the Japanese yen rises 6% against the dollar, a company’s earnings from Japan will automatically increase 6% when they are brought home.

One blue chip company we like that does a great deal of business overseas is Coca Cola (KO). The company just announced that third quarter earnings rose 7.8% from the same period last year.

Geographically, Coke saw 12% growth in Europe and Africa, with Russia leading the pack at 30%. Latin American volume rose 4%, with Brazil up 13%. The Pacific region grew 11%. By contrast, U.S. growth was only 2%.

We first recommended Coca Cola in May 2007 when it was selling for $47.24. The price is now $61.24, a 29.6% increase. We expect that more gains are on the way. And if the U.S. dollar declines as many analysts expect, Coke’s returns will be even sweeter. The stock currently pays a 2.90% dividend.

The Bottom Line

The stock market is still rising, partly in response to the Fed’s upcoming QE2 stimulus program that investors think will be good for the economy. The downside is the monetary boost may lower the value of the dollar and increase the inflation rate.

Investors have been responding to the threat of inflation and a weak dollar by buying gold, foreign currencies, and other traditional hedges.

For most investors we think the best inflation strategy is to open accounts in a strong commodity currency such as Canadian dollars, or buy the respective exchange traded fund, CurrencyShares Canadian Dollar Trust (FXC). We also like the outlooks for stocks with large foreign operations. Among them, BHP Billiton and Coca Cola look especially attractive.

Until Next Time

The AIA "Advocate For Absolute Returns", a publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn't? Many sources report these issues as abstract facts. We feel that's not enough. The AIA Advocate's job is to warn you of what's important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next time...


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Posted 10-28-2010 4:51 PM by Research & Editorial Staff