-- Published: Thursday, 5 June 2014 | Print  | Disqus 

The S&P 500 continues to hit new all time highs, but is your portfolio built on a house of cards? The politics to kick the proverbial can down the road may unleash dynamics that could be hazardous to your wealth.

The one thing politicians throughout the world have in common is that they rarely ever blame themselves. They tend to diffuse responsibility or place blame on groups such as political opponents, the wealthy, or foreigners.

If you now add that we have very real and major challenges in the world, it may be reasonable to assume that policy makers will continue to remain engaged in “fixing” things by blaming others. As an investor, if nothing else, this means asset prices may continue to move away from fundamentals and reflect the next perceived intervention by policy makers. This presents challenges for investors trying to maintain the real purchasing power of their portfolio and avoid a major drawdown at the wrong time.

Going forward we may continue to see less political stability as weakness in the real economy breeds discontent. In the U.S., they vote for more populist politicians, helping to explain the rise of the Tea Party and the Occupy Wall Street movement. In the Middle East, where rising food and energy prices comprise a much bigger portion of disposable income, people revolt as they can’t feed themselves anymore. In Japan, Abenomics is introduced by a populist prime minister.

Meanwhile both monetary and fiscal policy create a more challenging landscape for real economic prosperity to emerge. Instead of a rebirth following the global financial crisis we get a phony house of cards that may come down on the heads of investors who think that policy makers have their best interests in mind.

One of the most relevant dynamics for investors to be aware of is that the interests of a government in debt are not aligned with the interests of investors. A government in debt has an incentive to debase the value of its debt, whereas investors have an interest in earning a positive real return on their savings.

Last week, I attended a conference at Stanford’s Hoover Institution, where academics, as well as four acting Fed Presidents, pondered about the future of central banking. One of the presenters, Stanford Professor Dr. Martin Schneider, had some blunt words that were as obvious as they were controversial: monetary policy cannot be conducted in a vacuum, and is very much dependent on fiscal policy. He pointed out that as interest rates rise, taxes would have to go up to pay for the higher cost of servicing the debt. Dr. Schneider presented a simplified model of the world, arguing that in the U.S., in today’s environment, both government and citizens would benefit from inflation- the losers are foreigners. Now anyone can take issue with a simplified model; and I could also argue why everyone loses with inflation. Such details should not distract from the message, though:

• Inflation debases the value of government debt
• Inflation debases the value of consumer debt
• If you are a consumer with savings, sorry, you are in the minority and your interests will have to take a back seat
• Given that foreigners hold large amounts of Treasuries, they are on the losing end in an inflationary environment

We can argue whether inflation is a problem today or whether it is not. But it’s difficult for me to argue with the above. The conclusions I draw are:

• Political stability throughout the world will continue to decline
• Traditional diversification can’t be relied upon as asset prices reflect the next perceived move of policy makers rather than fundamentals
• Asset bubbles will be fostered
• Bonds are vulnerable
• The U.S. dollar is vulnerable
• Investors may need a toolbox to counter the toolbox of policy makers

The investment tools we have been focusing on to tackle these challenges at the core are currencies and gold. Gold may do well as the value of debt (and with it the dollar) is debased; gold also has historically had a low correlation to other asset classes, thus serving as a candidate diversifier going forward. Currencies can also serve as valuable tools: with currencies, one can design a portfolio that has a low correlation to other asset classes; currencies are historically less volatile than gold. On the other hand, other countries also face challenges, so some thought has to be put into a currency driven strategy.

We can’t know for certain that either currencies or gold will protect investors against a collapse of the proverbial house of cards, but we are afraid that ignoring these dynamics could be perilous. I will expand on this discussion and provide more feedback from my takeaway of what the Fed Presidents and others said at the above conference in our upcoming webinar on Wednesday, June 24 at 4:14 ET please register.

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Axel Merk

Axel Merk is President and Chief Investment Officer, Merk Investments,
Manager of the Merk Funds.

This report was prepared by Merk Investments LLC,and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Merk Investments LLC makes no representation regarding the advisability of investing in the products herein. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute investment advice and is not intended as an endorsement of any specific investment. The information contained herein is general in nature and is provided solely for educational and informational purposes. The information provided does not constitute legal, financial or tax advice. You should obtain advice specific to your circumstances from your own legal, financial and tax advisors. As with any investment, past performance is no guarantee of future performance.

1. The ICE U.S. Dollar Index® (USDX) is a trade-weighted geometric average of the U.S. dollar’s value compared to a basket of six major global currencies (euro, Japanese yen, British pound, Canadian dollar, Swedish krona, Swiss franc) set by the ICE (IntercontinentalExchange) Futures US. It is not possible to invest directly in an index.

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 -- Published: Thursday, 5 June 2014 | E-Mail  | Print  | Source: GoldSeek.com

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Axel Merk Axel Merk is Manager of the Merk Hard Currency Fund

The Merk Hard Currency Fund is a no-load mutual fund that invests in a basket of hard currencies from countries with strong monetary policies assembled to protect against the depreciation of the U.S. dollar relative to other currencies. The Fund may serve as a valuable diversification component as it seeks to protect against a decline in the dollar while potentially mitigating stock market, credit and interest risks—with the ease of investing in a mutual fund.
The Fund may be appropriate for you if you are pursuing a long-term goal with a hard currency component to your portfolio; are willing to tolerate the risks associated with investments in foreign currencies; or are looking for a way to potentially mitigate downside risk in or profit from a secular bear market. For more information on the Fund and to download a prospectus, please visit www.merkfund.com.
Investors should consider the investment objectives, risks and charges and expenses of the Merk Hard Currency Fund carefully before investing. This and other information is in the prospectus, a copy of which may be obtained by visiting the Fund's website at www.merkfund.com or calling 866-MERK FUND. Please read the prospectus carefully before you invest.
The Fund primarily invests in foreign currencies and as such, changes in currency exchange rates will affect the value of what the Fund owns and the price of the Fund’s shares. Investing in foreign instruments bears a greater risk than investing in domestic instruments for reasons such as volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. The Fund is subject to interest rate risk which is the risk that debt securities in the Fund’s portfolio will decline in value because of increases in market interest rates. As a non-diversified fund, the Fund will be subject to more investment risk and potential for volatility than a diversified fund because its portfolio may, at times, focus on a limited number of issuers. The Fund may also invest in derivative securities which can be volatile and involve various types and degrees of risk. For a more complete discussion of these and other Fund risks please refer to the Fund’s prospectus. Foreside Fund Services, LLC, distributor.

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