Back in July, I wrote a piece on Seeking Alpha warning about high U.S. debt levels and the very real possibility that the U.S. dollar (US$) could lose its status as the reserve currency of choice (see Newmont: How To Profit From The Potential End of “King Dollar”). That’s because U.S. debt and deficit levels are soaring and the total public debt now exceeds 100% of annual GDP:
Source: St. Louis Federal Reserve
This week’s announcement by Federal Reserve Chairman Powell that the Fed expects interest rates to stay near zero until 2023 doesn’t help matters.
MarketWatch discussed these developments in what I consider a very important interview with billionaire and hedge-fund manager Ray Dalio, the founder of Bridgewater Associates. The interview is a must-read for all American investors.
The basic thesis of the interview is that America has not been a good steward of the benefits of capitalism, which has increasingly gone to fewer and fewer people even as the U.S. has created a mountain of debt. That leads to a loss of productivity and reduced opportunity for the country’s citizens.
And, as Dalio puts it, “Wealth cannot be created by creating debt and money.” The result, Dalio believes, is that the world is likely to change in “shocking ways” over the next five years, including a loss of faith in the U.S. dollar:
Within the next five years you could see a situation in which foreigners who have been lending money to the United States won’t want to.
I will let you read the article for the detailed analysis and historical perspectives, but the bottom line is that Dalio expects the US$ to weaken. As a result, Dalio sends a very important message to U.S. investors:
Worry as much about the value of your money as you worry about the value of your investments.
In other words, while investors pour over their portfolio spreadsheets and monthly statements and watch the day-to-day market performance of their favorites stocks, funds, and ETFs, Dalio says they should also consider the value of the currency that those investments are based on (i.e. US$).
How To Invest For A Weaker US$
Indeed, after the COVID-19 induced market correction in March, investors have had a front-row seat for an astonishing market rally that has demonstrated how disconnected Wall Street is from the Main Street economy. That’s because investors don’t want to own what is commonly thought of as the “safest investment” – cash. Cash at near-zero interest rates currently has a negative real rate of return when inflation is considered.
My followers are likely very familiar with my favorite anecdote – that puts in terms everyone can understand – that demonstrates how gold retains its purchasing power over time:
In the early 1900s, a 1-ounce US gold coin with a face value of $20 could buy you a very nice suit, shirt, belt, tie, and pair of shoes. Today, what could that $20 buy you – may be the belt? Yet, that 1 ounce of gold, currently worth $1,949, can still buy you a very nice suit, shirt, belt, tie, and pair of shoes.
The point is obvious: gold holds its value, and paper currencies do not.
So, the first-step every American should take to protect themselves against a falling U.S. dollar is to buy some gold. Personally, I am a big fan of U.S. gold coins (bullion) that can be bought on popular websites such as American Precious Metals Exchange (APMEX.com) or Kitco.com. In addition to gold bullion, investors can invest in what I call “paper gold”, the SPDR Gold ETF (GLD). Other options are gold funds and every “gold bug” has their favorite. I own a plain-old gold mutual fund (no 2X, or 3X action): Fidelity Select Gold (FSAGX). FSAGX owns shares in top gold producers like Newmont (NEM) and Barrick Gold (GOLD). Note also that the funds have a 66.6% exposure to the Canadian dollar versus a 19.4% weighting in the US$.
FSAGX has significantly outperformed GLD this year because gold miners are more highly levered to a rise in gold prices than gold itself. And note that both FSAGX and GLD have significantly outperformed the S&P 500 YTD:
Source: Seeking Alpha Charting Tool
And, of course, all three have outperformed the US$ Index this year. The US$ Index is down 4% YTD, but, more importantly, down 9.5% from the March high of 102.75. I say more importantly because, typically, the US$ has been a refuge in times of geopolitical “trouble” like a global pandemic. However, after a brief rally in March, the US$ has steadily sold off. American investors should take note. That is likely due to three primary factors:
- The US response to COVID-19.
- The massive increase in debt/deficits due to various “stimulus” bills.
- The near-zero interest rate environment is not likely to change until – according to Fed Chief Powell – 2023.
Investment advisors and investors have a wide range of opinions when it comes to how much exposure an individual should have to gold. Assuming a well-diversified portfolio (which does include cash for emergencies), my belief is that middle-class investors (net worth under $1 million), should own at least 5-10% in gold. I also believe that as an American investor’s net worth climbs, the higher that percentage should be because, in my opinion, he or she simply has more to lose by a falling US$. For instance, an investor with a net worth of $2-5 million might have a 15-20% exposure to gold; $10 million, perhaps a 30-40% exposure.
As for equities, obviously, the current rage is for companies that exhibit large revenue growth rates. Many of these companies (just read some of the companies I have covered lately) have astonishing valuations and could be traps for investors that can’t find a chair when the music stops. Meanwhile, there are more conservative approaches that could prove to be beneficial over the long term.
Take Enbridge (NYSE:ENB) for instance. This tier-1 liquids and natural gas pipeline company also runs a Canadian gas utility. It has a very secure dividend and yields 8%. Plus, the dividend is paid out in Canadian dollars (C$). As the U.S. dollar weakens, the dividend for American investors holding ENB shares on the NYSE goes up. In the most recent quarterly payout, my shares were paid over $0.01/share more in Q2 versus Q1 simply because the US$ weakened in comparison to the C$. Note that the C$ was trading near parity with the US$ back in 2013 but has dropped by ~25% since then. That was a headwind for US investors holding ENB shares (i.e. the dividend was reduced in US$ terms), but that could be changing. Note that Canada’s debt-to-GDP ratio is about half that of the U.S. (53.3%).
Other equity opportunities exist in overseas markets. As I recently reported in my Seeking Alpha article Why I Am So Bullish On China, the Chinese economy has come roaring back from the COVID-19 lows. Investors might consider owning an investment like the SPDR S&P China ETF (GXC) both from an economic growth perspective as well as the currency angle.
Another option for US investors would be something like the Consumer Staples Select Sector SPDR ETF (XLP). That’s because the XLP owns companies that have strong brand-name and indispensable consumer items and the ability to raise prices in an inflationary environment where the US$ is falling.
Another option for American investors that just can’t bring themselves to buy gold or foreign equities and prefer to invest here at home are I-bonds that can be purchased online at treasurydirect.gov. The composite rate for I bonds issued from May 1, 2020, through October 31, 2020, is 1.06%. This rate applies for the first 6 months you own the bond. Note that the return on I-bonds is calculated from a formula that contains both a fixed-rate and a semi-annually adjusted inflation rate. Currently, the fixed rate is 0.00%, down from 0.2% in November of 2019 and 0.5% in May of 2019. In September 1998, the fixed rate was 3.4%, and investors who bought those bonds are likely very happy today. But while the fixed rate is now undesirable, if inflation takes off due to a falling US$, these bonds could do well in the future. On the other hand, you have to have faith that the US government will pay them off.
Note that I-bond yields can’t go negative and that an I-bond is not the same as a TIP (treasury inflation protected security). That’s an important consideration in light of the fact that real interest rates are currently negative:
Summary & Conclusions
I found the MarketWatch interview with Ray Dalio to be spot-on. Perhaps that’s because Dalio’s views are in-line with my own and we all like to listen to people who agree with us. That said, it may be worth investors’ time to listen to his arguments and take some action to address the impact that a falling US$ may have on their portfolio.
Disclosure: I am/we are long ENB, NEM, FSAGX, XLP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am an engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for the investment decisions you make.