Monday, July 25, 2011

The Failure of Cash As a Store of Value: There Are Alternatives

For years, the policies Alan Greenspan and Ben Bernanke of setting short-term interest rates near zero percent have been perverse.  They have penalized the prudent (savers) by producing a negative real, after-tax return.  They have rewarded the speculators, who borrowed at near zero percent and levered up in various markets that offered a positive interest-rate spread (the “carry trade”).  This effectively removed a primary role of a nation’s currency—a “store of value.”

For those who were willing to reduce their liquidity and venture out with a longer-term commitment to earn an after-inflation yield of zero or more, yields of 3.5%-4.5% on intermediate- to long-term U.S. Government bonds haven’t seemed high enough to justify the risk posed by deteriorating Government finances.  It has been necessary to be creative in addressing this conundrum.

There have been two creative alternatives for protecting the purchasing power of cash reserves.  The first has been to purchase hard (or “soft” agricultural) assets, whose values have been rising because of imprudent central-bank policies and the decline in the foreign-exchange value of the U.S. Dollar.  Hard assets can be purchased directly, but there are storage and illiquidity issues from that approach.  Alternatively, there are exchange-traded funds whose prices are linked to assets such as gold, agricultural commodities, oil, and natural gas (among others).  The price of gold is up 35% over the past year, and the price of my favorite agricultural ETF (the Rogers Index—symbol RJA) is up 35%.  Now that’s a store of value! 

Despite the likelihood of a near-term correction after such a sharp rise, both gold and agricultural commodities remain attractive, as do other hard assets.  Gold will likely continue to rise unless the world becomes more peaceful and governments become fiscally responsible.  Agricultural commodities remain historically cheap on an inflation-adjusted basis compared to other goods and asset markets.  Oil faces increased scarcity, in my view, and natural gas prices are quite inexpensive on a BTU basis.  In addition, expansion of liquefied natural gas capacity will facilitate gas becoming more of a global fuel.  The price of natural gas is less than half what it was in the summer of 2008.  There is an ETF (symbol:  UNG) linked to the price of gas.

The second creative alternative to sitting on U.S. cash that yields close to zero is foreign currencies.  While institutional investors have ready access to forward contracts on currencies and to short-term government bonds in other countries that individuals cannot easily purchase, there are ETF’s linked to foreign currencies.  Various ETF’s linked to foreign currencies have been excellent stores of value over the past year.  Examples include the Australian dollar (+21%), the Swedish Krona (+13%), and the Canadian dollar (+9%).  Australia, of course, benefits from strong commodity demand, as does Canada, particularly from the rising price of oil.  Sweden, my preference relative to the Euro for several years, has a budget surplus and healthy GDP growth.

So there are alternative stores of value for investors.  After all, given the doubling of stock prices over the past two years and a sharp rise in corporate bond prices as well, it is prudent to keep reserves (a store of value) in anticipation of better investment opportunities in the future.   

Steve Lehman

S & P 500:  1340
Russell 2000:  837

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