Guide to protecting your portfolio from the ravages of the currency wars
Russia, China and the U.S. are in a battle for currency dominance and natural resource stocks have been buffeted as a result. When the dust settles, smart natural resource investors could be the big winners as long as they have taken the right protective measures. In this interview with The Gold Report, Sprott USA Holdings CEO Rick Rule and Stansberry & Associates Investment Research founder Porter Stansberry—the men behind the upcoming Sprott-Stansberry Vancouver Natural Resource Symposium—share their strategies for picking good companies no matter what happens on the political front.
The Gold Report: One of the themes of the Sprott-Stansberry Vancouver Natural Resource Symposium at the end of July is "the global currency war." From your perspectives, who are the major stakeholders in this war and what can investors do to protect themselves?
Porter Stansberry: The three major stakeholders in the currency war are the United States, China and Europe. The volatility in those currencies over the last 18 months has been historic. It has resulted in even greater volatility in more minor currencies, including the huge moves that have occurred in the Swiss franc. I expect to see China and the yuan join the International Monetary Fund (IMF) currency basket, which will lead to a very significant and large move of reserve currencies into the Chinese yuan. That will definitely have the impact of weakening the euro and the dollar.
TGR: Do you expect the yuan to replace the U.S. dollar as the world's reserve currency or will there be a dual reserve currency?
PS: I do not believe that the U.S. dollar will be replaced in the short term. What is significant is that the amount of dollars held as a reserve around the world has been reduced and continues to decline dramatically. Twenty years ago, U.S. dollars made up more than 80% of all reserve currencies around the world. Today, that number is closer to 60%. I think after the inclusion of the yuan, we're going to see the dollar drop below 50%. This means at the margin it will become harder for the United States to borrow abroad and it will become more difficult for the U.S. to finance its debts.
Rick Rule: I agree with Porter. It's difficult for the yuan to replace the U.S. dollar. The yuan could, however, challenge the hegemony of the U.S. dollar. I think that the Chinese are making efforts to make their markets more transparent, but the Chinese central government's need for control will make it difficult for the Chinese debt markets to rival the U.S. dollar's role.
I will tell you why. I questioned an Asian investor at one point about the size of his U.S. treasury portfolio and commented that I considered the U.S. treasury to represent return-free risk. He looked at me, smiled and said, "What you say is true, but we still trust you more than we trust each other." When I referred to the U.S. 10-year treasury as being sort of a fiscal lie, the same man smiled and said, "Yes, but a deep, transparent, liquid lie." I think that's illustrative of where we are in the market now.
PS: Any country whose currency is used as a reserve enjoys tremendous benefits because those currencies gain a significant discount to financing costs. They're able to float huge amounts of credit around the world. Today, almost all currencies are traded primarily in dollars. The fear is that if the dollar falls below 50% of the currency basket held by commercial and central banks and insurance companies, there may be a democratization of the way currencies are priced. The huge growth in bilateral trade agreements between Russia and China or China and Australia foreshadow a time where there will be no need at all for those economies to deal in dollars. That will significantly reduce demand for dollars held overseas.
TGR: As commodities move to trading outside U.S. dollars, will we see more volatility in prices?
PS: We are going to see unprecedented volatility in currency values. This has already happened. It makes no sense whatsoever for the euro to have declined 40% against the dollar in the last 18 months. These are the two largest economic zones in the world. How can the global economy function if the weights and the measures between these two trading blocks are constantly in such flux? It becomes impossible for producers and consumers to hedge the currency risk because of the volatility and the cost involved in hedging. These are big impediments to global growth and enormous opportunities for speculators. That's great for newsletter publishers and retirees who can trade currencies successfully, but it has a terrible impact on growth and the increasing value of wealth around the world.
TGR: How will this currency war end?
PS: That's the $64,000 question, isn't it, Rick? Currency regimes in the past were always destroyed by volatility. So sooner or later, people desire a currency that is stable. Of the three major players in the currency wars, which currency do you think is most likely to become the most reliable? Do you think it's the euro, which is falling apart by the seams as the world watches? Is it the dollar, which supports unfunded liabilities of $200 trillion ($200T)? Or do you think it's the yuan, which has a massive labor pool, tremendous domestic savings, giant trade surpluses and huge natural resource capability? I don't think it's very hard to figure out which of those currencies over the long term is going to be the most stable.
TGR: What does that mean for natural resources and the attendees at your conference?
RR: The currency wars are particularly good for precious metals, which have traditionally fared well in times of fear. It's worth noting that precious metals, unlike most other commodities, respond to both greed and fear. But in my experience, fear has usually been the catalyst that begins to move precious metals higher. The volatility that Porter talks about, particularly downside volatility associated with currency, is what motivates people to store part of their wealth in precious metals.
This connection between currency values and natural resources is evident historically. The increase we saw in natural resource prices in 2001, 2002 and the beginning of 2003 had more to do with the rollover in U.S. dollars than it did with actual increases in resource prices in other currencies. In 2000, the gold price performed very well in all currencies in the world with the exception of the U.S. dollar. In 2001, we began to see gold rising in tandem with the U.S. dollar, and as the U.S. dollar rolled over, we saw a commodities bull market get underway in earnest. There were fundamental factors associated with the bull market in resources to be sure, particularly emerging markets' demand, but the beginning part of that bull market really was the rollover in purchasing power of the U.S. dollar. The scenario Porter described will benefit natural resource prices and, by extension, investors who are prepared for the coming shift.