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US Dollar Weakness Has a Major Impact on Investment Landscape

The following is the Investment Commentary that I wrote and included with our clients month-end statements. We like to keep our clients informed about our investment activities and the things that are happening to impact their portfolios.

If your investment manager does not provide this sort of information as a value added service, we would love to help you with your investment management. Just email me at ballard@bankchampaign.com or call me at (217) 351-2870 to discuss.

On the graph at the end of this Investment Commentary, you can see that the US Dollar is in a sustained bear market. It broke to new 2009 lows last week and continues to weaken. This weakening has major implications for the stock and bond markets, so I thought a discussion here would be prudent.

Many of you received our periodic “Investment Strategies” newsletter last week. In it, I discussed where we see the stock market headed in the short and intermediate terms. Since the newsletter was published, the breakdown in the dollar occured and is having a major impact on certain investment themes we are following. If you did not receive our newsletter, please call Melodie Davis at (217) 351-2870 to request one be sent to you and to be added to the mailing list for future issues.

There are many theories being floated as to why the dollar has taken such a tumble. I believe it is because the investment community realizes that this country has adopted a loose monetary policy in an effort to first save our financial system from collapse after the Lehman Brother’s bankruptcy in September, 2008, and subsequently to bring our economy out of the current recession.

What the investment community sees is a Federal Reserve that has doubled the size of its balance sheet, lowered interest rates to near zero percent, and is now printing money to buy treasury bonds. Historically, these actions have always preceeded rising inflation. Additionally, our government is projecting a $1 trillion deficit for this year and many into the future. The investment community understands that the only way to fund that deficit is to issue treasury bonds, and they project that our Federal Reserve will almost certainly end up buying a portion of that debt with the resulting printing of additional dollars. Rising inflation devalues the purchasing power of the dollar, decreases its value compared to foreign currencies, and impacts investment decisions in a major way.

So, what investment types are the beneficiary of a falling dollar? As the value of the dollar goes down, the investment community moves its collective wealth into other stores of value. Assets like oil and precious metals are beneficiaries of the falling dollar as buying demand for them increases and their prices increase as a result. The other big beneficiary of a falling dollar is the group of domestic corporations that have significant foreign sales (e.g., McDonalds and 3M). Because they are earning a significant portion of their revenues in currencies that are increasing in value, when they are translated back into dollars for earnings reports they have the benefit of foreign currency gains in addition to rising sales.

As far as bonds go, expectations for rising inflation generally are bad for bonds. Bonds lose value as the investment community anticipates interest rates rising. We have started to add to client accounts Treasury Inflation Protected Securites, which actually gain value as expectations for interest rates rise. We are also maintaining our use of laddered certificates of deposit that do not lose market value as interest rates change.

These actions in stock and bond portfolios are designed to protect our clients from the resulting negative impact of a falling dollar and to take advantage of the positive impact in certain investment classes.

This is obviously a simplified explanation of a very complex phenomenon. However, I wanted you to understand that in our investment strategy, we will likely be stressing the investments that fit the theme of a falling dollar. We are watching this situation very closely, and if we see a confirmation that the move to the downside is gaining momentum, we will update you in our blog: http://investmentblog.bankchampaign.com/

Thank you for your continued business, and if you have ever any questions or if you have additional funds that you would like for us to manage according to our strategy, please do not hesitate to contact us.

dollar-vs-gold-oil-2009-08-05

Note the break of support (the pink line) by the dollar (the red line). See how the price of gold (the gold line) and oil (the black line) move up as the dollar moves down. The teal line represents the primary trend of the dollar and you can see that it is decisively down.