A Pfennig For Your Thoughts

In This Issue…

  • FOMC Rules the day
  • Euro confidence soars
  • End of year repatriation rallies yen
  • Silver shines

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And Now… Today’s Pfennig!

Waiting for the Fed 2

Good day… Yesterday turned out just as expected, with little going on in the currency markets. All traders are waiting for the FOMC release this morning and, more importantly, the statement that will follow. The markets are looking for a sign that the interest rate increases we have seen over the last 14 meetings will be coming to an end. Today’s release is therefore extremely important as it will set the tone for the US$ for weeks to come.

In addition to today’s statement, there are five different central bankers scheduled to speak this week, so the Fed will have ample opportunity to ‘jawbone’ the markets or to clarify and explain their decision. I look for the Fed to signal an end to these rate increases and perhaps shift the focus on the data that we will be getting over the next few days. This release should set the stage for the U.S. dollar to get back on the long-term trend downward that it began in Feb of 2002.

With the U.S. markets waiting on the Fed, data released this morning in Europe rallied the euro and pound sterling. Business confidence in Germany, Europe’s largest economy, unexpectedly increased in March. The surge in IFO confidence index to the highest in almost 15 years prompted traders to raise bets that the ECB will continue to boost its key interest rate. The euro is up 1.8% vs. the US$ in 2006 and with the FOMC expected to end rate increases, the euro should continue to rise.

Even though interest rates are currently lower than in the U.S., investors should look to use the euro as one of their core currency holdings. The euro is the world’s secondary reserve currency, and as the US$ gets sold by central banks looking to diversify, the euro is one currency that will certainly be bought. Again, investors should not just focus on interest rates, but should look at what the currency is expected to do vs. the US$. Euros should be part of every portfolio.

The pound sterling also gained overnight on speculation the UK housing market is rebounding, adding to the case for the central bank to keep interest rates on hold this year. As you will remember, the pound sold off earlier this year when traders began to believe the BOE would cut rates. Chuck cautioned readers against selling into these rumors as we didn’t believe there would be additional cuts after last August’s move. It now looks like rates will be put on hold for the rest of 2006, and the pound should hold steady.

The Icelandic krona was able to rally a bit overnight as it matched gains in the euro. Investors have been disappointed by this currency over the past month, but economists smarter than I am are still suggesting that the currency will come back. Dr. Steve Sjuggerud had this to say in a recent email:

“In the last month, Iceland’s currency has been beaten up. Danske Bank, a Scandinavian bank, warned of a financial crisis in the country. After investigating, I’m not worried. Iceland’s fundamentals are sound. (I’ve put links for more information at the bottom of this letter).

In short, I think Iceland’s currency (the krona) generally behaves like a euro. However, it got overvalued recently, as foreign speculators became attracted to Iceland’s high interest rates. At the first sign of trouble, these speculators are leaving. It’s as simple as that.

Once the currency settles down, I really do believe certain Icelandic bonds will be the best bond plays in the world for the next eight years.

If you’ve gotten in recently, don’t get rattled. Hang in there.

As I explain in the latest issue of True Wealth, there’s a great new reason why Iceland’s currency will “converge” with the euro once again someday. And it could make you a lot of money…”

Again, this currency is speculative in nature and should only be held as a small percentage of your overall currency portfolio. If you bought it for the interest rate alone, it was for the wrong reason and you should probably look to move to a more stable currency. But for those who use it as their speculative currency investment, Dr. Sjuggerud believes it will be moving up along with the euro, so hold on.

The Japanese yen strengthened for a third day as investors started to bring money home before the end of the financial year on March 31. An improving Japanese economy will likely make this year’s repatriation even larger than years past. The yen has climbed against the US$ in March of three of the past four years, with the exception of 2005. With the underlying fundamentals in Japan much more supportive this year, we expect the Japanese businesses and investors to bring home a larger percentage of their currency. While some of the BOJ members continue to manipulate the currency downward, it is becoming more apparent that interest rates will have to rise in Japan sometime this year. These higher yields will certainly trigger Japanese investors to sell overseas assets, benefiting the yen but putting additional selling pressure on the New Zealand dollars.

The rising yen, along with a strengthening Chinese renminbi will likely bring all of the Asian currencies along for the ride. Rising yen and renminbi will make exports by these two countries more expensive relative to those of their regional competitors. Exports make up over 50% of the economies of Thailand and account for almost 70% of Singapore’s non-oil domestic exports. We continue to suggest investors get exposure to the Asian markets by purchasing Thai baht 3-month CDs where in addition to the currency appreciation, you get an interest rate of over 3% (high for Asia!). We also like investments in Singapore as the currency will continue to follow the yen upward.

China’s foreign-exchange reserves overtook Japan’s as the world’s largest, reaching 853.7 billion by the end of last month, the state-owned China Business News said. These reserves have doubled in the past two years and passed Japan’s 850.1 billion last month. A record trade surplus has pushed the reserves higher and will continue to increase pressure on the renminbi to strengthen.

The holdings are so large that China is shifting more of the added reserves into euros and yen to reduce its exposure to dollar-denominated assets. Currently the reserves are thought to be between 70 and 80 percent in dollars. China held $262.6 billion in U.S. government treasury bonds at the end of January, making it the largest investor after Japan. It will be interesting to see what happens as China begins shifting out of these U.S. treasuries and diversifying into other currencies. I can assure you of one thing, it won’t be good for the US$ or interest rates in this country!

A strategist at JP Morgan believes the move will be even larger. In a report released yesterday, they predict the renminbi will gain about 12% this year as sustained economic growth persuades Chinese policy makers to allow gains in the currency. “Its definitely the case that the yuan (renminbi) is going to be allowed to appreciate as the economy grows.” The renminbi will advance to 7 against the U.S. dollar by year-end according to JP Morgan. Again, an appreciating renminbi will take the rest of Asian currencies with it, so look for good returns in all of the Asian currencies in 2006.

I was asked to give an interview to a LA radio station yesterday regarding the recent run-up of silver. Unfortunately the interview got bumped by some local news, but I figured I would share the research I did with the Pfennig readers. Silver reached a 22-year high yesterday and is on track for its best year since the billionaire Hunt brothers caused prices to skyrocket in 1979. Investors in EverBank’s Metals Select accounts have been using these investments as a hedge against inflation and also as a bet on the possible introduction of a Silver ETF.

As an inflation hedge, both silver and gold are excellent investments. As the big boss, Frank Trotter, pointed out to me yesterday, the British pound sterling was originally equivalent to a pound of sterling silver. By looking at the value of each today, you can see which has been a better hedge on inflation. The British pound is currently worth just over $1.75 but a pound of sterling silver is currently worth over $174.

The silver ETF Barclay’s is planning to introduce will certainly put a squeeze on the supply – demand in silver. Barclay’s plans are to eventually sell 13 million shares of the ETF with each share representing 10 ounces. This will mean an additional 130 million ounces of demand added to a market that is already tight. EverBank’s silver pooled accounts are actually a more efficient investment vehicle than the proposed ETF. I encourage investors interested in adding metals to your portfolio to contact the trading desk at 800-926-4922 regarding these accounts.

Currencies today: A$ .7114, kiwi .6110, C$ .8582, euro 1.2088, sterling 1.7503, Swiss .7694, ISK 71.50, rand 6.2775, krone 6.5676, forint 219.91, zloty 3.2552, koruna 23.7663, yen 116.68, baht 38.85, sing 1.6170, China 8.02, pesos 10.98, dollar index 89.64, silver $10.85, and gold… $565.15

That’s it for today… We are all waiting patiently for the FOMC release that will come this afternoon. Look for a volatile day in the currency markets. I believe the dollar will start to be sold today, and the sell-off will likely continue the rest of the week as we get additional data released in the U.S. Hope everyone has a great Tuesday!

Chris Gaffney, CFA
Vice President
EverBank World Markets