27/5/2013
Goh Eng Yeow
IT USED to be a simple no-brainer strategy: You can win big-time if you make a wager that stock prices will go up each time the US dollar turns wobbly.
So it comes as a surprise to find that the global stock market rally is still in full swing, even though the greenback has been strengthening of late.
Since September, the US dollar has jumped 32 per cent against the yen and about 3 per cent against the yuan. In the same period, it has also rallied 3.4 per cent against the Singapore dollar, with about three-quarters of that rise occurring in the last two weeks.
To many people, this does not make sense. There is no reason for the greenback to rally, given the determination of the United States central bank to expand the money supply by buying US$85 billion (S$107.5 billion) of US government bonds and mortgage securities every month.
In theory, that should depress the value of the dollar, since there is a lot more of it in circulation. And this was what happened in 2009 and 2010 during the US' previous two rounds of quantitative easing (QE), as its money-printing process is described.
On both occasions, investors had been so fearful of the inflation that QE might spawn that they fled to "safer" assets such as gold. Their rationale was simple: Unlike fiat money whose supply can be expanded simply by printing more of it, one cannot conjure up more gold than what is available in the form of gold bars or jewellery, or remaining in the ground to be mined.
So there appears to be a big contradiction with the latest QE. More and more US dollars are being printed, yet the greenback's value appreciates against other currencies. And while there is no sharp increase in the supply of gold, its price has crashed about 22 per cent in US-dollar terms in the past six months.
Another puzzle needs to be explained. Even though the US dollar is up, Wall Street is still partying away. Since January, the Dow Jones Industrial Average has jumped by 17.2 per cent.
One possible explanation for the strengthening US dollar could be the sheer abundance of shale gas in the United States which is dampening energy prices in a big way. In the past nine months, Brent crude had tumbled by 11.4 per cent.
That may have allowed the US Federal Reserve to get away with its manic money-printing programme for now, as lower energy costs keep the lid on inflationary pressures.
In its semi-annual report recently, the International Energy Agency predicted that the rising US shale oil production would help to meet most of the world's rise in oil demand for the next five years.
That would leave Opec with little room to lift production without risking a big drop in oil prices, or ask for a higher price in US-dollar terms since alternative US supplies would be available to make up the shortfall.
The US external trade balance can only get better if US oil producers get the go-ahead to export the black stuff - all very good news for the greenback.
As the US is less dependent on exports than many major economies, it may actually benefit from a stronger currency.
As the US dollar strengthens and Opec loses its pricing clout, that can only mean bad news for gold - the traditional hedge against inflation.
That should give the Fed more leeway to print money to keep borrowing costs extremely low to spur the still weak US consumer demand without stoking inflation in a big way.
What should investors do? If this argument holds true, the US stock market may prove to be attractive, as the US benefits from a stronger currency and US manufacturing enjoys a renaissance with cheap shale gas lowering production costs.
The flip side of the strengthening dollar is a weakening yen.
It does not take a financial expert to explain why a falling yen is good for the Tokyo stock market, as it spells strong profits for Japanese firms.
Toyota Motor, for example, had estimated that every one-yen swing against the US dollar would produce US$397 million in extra profits for the company.
Since Japanese Premier Shinzo Abe demanded a much more aggressive monetary policy, following his electoral victory last December, the Nikkei-225 index has behaved like it is on steroids as it climbs 48 per cent in just six months, as the yen plummets.
For Asian markets, there is the prospect of history repeating itself once again, as borrowing in yen becomes fashionable again and Japanese money floods the region once again in search of higher returns.
One decade ago, the yen carry trade - the description for the massive yen loans taken out by traders and speculators because of Japan's low interest rates to buy higher-yielding assets - was the single most powerful driver propelling South-east Asian markets higher. That day may yet return.
engyeow@sph.com.sg
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