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Gold Price Trend Forecast Summer 2019

S&P U.S.Debt Downgrade, Don't Shoot the Messenger

Interest-Rates / Credit Crisis 2011 Aug 08, 2011 - 03:08 PM GMT

By: Axel_Merk

Interest-Rates

Best Financial Markets Analysis ArticleDon't shoot the messenger. The downgrade of U.S. government debt by S&P is the result of policies pursued over many years that rely on the U.S. being the world's reserve currency. Policy makers have forgotten that the status must be earned; it's not a birthright.


Some thoughts on the downgrade, as well as recent ECB actions:

With large-scale bond purchases announced, the ECB is moving closer to how the Fed operates in a crisis. In 2008, then NY Fed President Geithner conferred with Treasury Secretary Paulson whether to "foam" the markets. That referred to massive liquidity injection by buying Treasuries.

Now the ECB may buy bonds of the largest European bond market, the Italian. The ECB has indicated it would sterilize any purchases, i.e. not print money on a net basis.

Last Thursday, when the ECB announced it would reopen its six-month funding facility, the central bank may have received a heads up from S&P of the looming U.S. downgrade. The ECB is concerned about a shock that would shun Italy and Spain from the funding markets.

Let's not forget that some of the market tension comes from U.S. money market funds having dumped commercial paper issued by European banks after a lot of scrutiny (we added to that). This is more a re-pricing of funding costs, adding to the pressure that European banks should raise capital, a process long overdue.

Some more thoughts on S&P downgrade;

  • Ratings agencies don't want to be caught late in downgrading anyone these days. As such, many may initially shrug off the downgrade. Especially since S&P only points out the obvious, which presumably should be priced in; that said, there is no way to put a positive spin on the downgrade, especially given the negative outlook that accompanied it.
  • Initial bond reaction may be a rebalancing of some portfolios to increase average security quality. This may have the ironic effect of increasing allocations to Treasury securities. However, while this logic may apply to select U.S. institutional managers, international managers may veer to other securities.
  • One beneficiary has been corporates - the market appears to embrace some corporations as more creditworthy than the U.S. government.
  • Foreign institutional managers, however, may choose sovereigns elsewhere; not necessarily immediately, but over time.
  • And in general, the downgrade may precipitate de-leveraging, as more collateral may be required. Recently, we have seen signals that U.S. regulators won't require more collateral, but market forces may still move in that direction, if only on the margin [pun intended]
  • Net, we see a slight negative for commodity currencies as part of the de-leveraging trend, but a plus for the Euro, as the playing field is leveled - the Chinese are now given the green light to diversify in earnest out of the U.S. dollar. Other Asian currencies should also appreciate, although it may only happen in the medium term.
  • Keep an eye on the Fed this week. We expect them to move closer to, or even announce that maturing Treasury securities will be invested in the middle of the yield curve. That should overwhelm the S&P headlines in the short term, causing dollar weakness across the board.

Long term, more pronounced damage is likely to occur in the bond market, but like a frog in a boiling pot, the pundits will likely shrug off this view, as the initial bond market reaction may not be too severe. Politicians will simply complain, but not change. And that will cause further downgrades...

At Merk, our hard currency strategy saw substantial shifts last Thursday and Friday with reductions in the Canadian, Australian and New Zealand dollar, with money re-allocated to the Euro, Norwegian Krone and Japanese Yen. We did not foresee the timing of the downgrade, but positioned ourselves for further global de-leveraging and long-term dollar weakness. The downgrade is a symptom, not a trigger, of the environment we are in.

Having said all this, the situation may be fluid and we may also change our minds. The market is never wrong... Sometimes a bit early or late...

Ensure you sign up for our newsletter to stay informed as these dynamics unfold. We manage the Merk Absolute Return Currency Fund, the Merk Asian Currency Fund, and the Merk Hard Currency Fund; transparent no-load currency mutual funds that do not typically employ leverage. To learn more about the Funds, please visit www.merkfunds.com.

By Axel Merk

Manager of the Merk Hard, Asian and Absolute Return Currency Funds, www.merkfunds.com

Axel Merk, President & CIO of Merk Investments, LLC, is an expert on hard money, macro trends and international investing. He is considered an authority on currencies. Axel Merk wrote the book on Sustainable Wealth; order your copy today.

The Merk Absolute Return Currency Fund seeks to generate positive absolute returns by investing in currencies. The Fund is a pure-play on currencies, aiming to profit regardless of the direction of the U.S. dollar or traditional asset classes.

The Merk Asian Currency Fund seeks to profit from a rise in Asian currencies versus the U.S. dollar. The Fund typically invests in a basket of Asian currencies that may include, but are not limited to, the currencies of China, Hong Kong, Japan, India, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand.

The Merk Hard Currency Fund seeks to profit from a rise in hard currencies versus the U.S. dollar. Hard currencies are currencies backed by sound monetary policy; sound monetary policy focuses on price stability.

The Funds may be appropriate for you if you are pursuing a long-term goal with a 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 Funds and to download a prospectus, please visit www.merkfunds.com.

Investors should consider the investment objectives, risks and charges and expenses of the Merk Funds carefully before investing. This and other information is in the prospectus, a copy of which may be obtained by visiting the Funds' website at www.merkfunds.com or calling 866-MERK FUND. Please read the prospectus carefully before you invest.

The Funds primarily invest in foreign currencies and as such, changes in currency exchange rates will affect the value of what the Funds own and the price of the Funds' 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 Funds are subject to interest rate risk which is the risk that debt securities in the Funds' portfolio will decline in value because of increases in market interest rates. The Funds may also invest in derivative securities which can be volatile and involve various types and degrees of risk. As a non-diversified fund, the Merk Hard Currency 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. For a more complete discussion of these and other Fund risks please refer to the Funds' prospectuses.

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. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute investment advice. Foreside Fund Services, LLC, distributor.

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