A Greenback Alternative Part 2 – “Large Cap” Versus “Small Cap”
Justice Litle, Editorial Director, Taipan Publishing Group
If countries are like companies, which ones to buy? To answer that question, we begin with the characteristics of a good long-term investment – and then consider the merits of “large cap” versus “small cap” currencies.
Earlier this week, we explored how fiat currencies are like shares of stock. The question was then asked: If countries are like companies, which ones should we buy?
One can begin with the qualifications of a good long-term stock investment. Here are a few:
• A strong management team
• A clean and stable balance sheet (not too much debt)
• Attractive assets on the books
• Positive cash flow
• An “economic moat” (sustainable competitive advantage)
• Clear opportunities for long-term growth
• Attractive valuation (relative to long-term prospects)
As an investor, when you find a company that hits all the above criteria, you don’t just dip a toe in the water. You buy a good slug of shares and hold on for years.
One can think about countries (and thus currencies) the same way. For a country, the “management team” is akin to political leadership. The “balance sheet” is akin to the balance of payments (and long-term debt levels). “Attractive assets” count for things like natural resources and human capital. Positive cash flow reflects the balance of trade… and so on. You get the idea.
By the above criteria, the “big three” currencies – the euro, the yen, and of course the USD – all look like dog poo.
Europe and Japan Grow Violently Ill
Before we continue, it should be noted that the U.S. dollar is in a clear uptrend right now. Taipan Daily anticipated this would happen back in early December.
In case you missed it, in Dec. 9 we ran Taipan Daily “Outbreak Alert – P1N1 Forex Flu.” In that piece we said the following:
Even though the $USD is the carrier, and the U.S. central banking system is “Patient Zero,” America has a sort of built-in immune system defense (by virtue of its still unchallenged world reserve currency status)…
“Patient Zero” is also stronger than average. Even now, the U.S. economy is large, powerful and diverse relative to most others. Again, the U.S. is the keeper of the world’s reserve currency. Its government debt is the most desirable. It is home base for the most liquid capital markets in the world.
These superlatives may eventually slip away, but they have not done so yet. The above traits make the U.S. like a big, burly individual who can handle being sick better than others.
Think of the lumberjack with a hardy constitution who laughs at the prospect of a nasty cold. What happens when that cold is passed on to someone smaller… frailer… weaker? Perhaps the lumberjack shrugs and goes back to work – while the weaker individual finds himself in a hospital bed.
Countries like Iceland and Latvia have already learned this lesson the hard way.
In the early Taipan Daily P1N1 piece, we then went on to note the clear signs of “outbreak” in countries like Japan, Greece, Britain and Venezuela.
Since that broadcast, the euro has plummeted to multi-month lows as the Greece situation gets splashed all over the financial papers. (By the way, Spain could be next.) Japan has been told by the financial wizards at PIMCO that it must “reflate or die.” Venezuela has pushed through an emergency 50% devaluation of its currency. And Britain, by some observers’ grim estimations, is still on track to becoming another Iceland.
The point here is that, although the U.S. dollar now rises, it does not do so out of virtue. The fresh $USD uptrend is born of size, circumstance, and the inertia of historical advantage. In sheer circulation terms, the greenback is the biggest game in town… and if balance sheet woes count as sickness, king dollar’s major competitors (i.e. the euro and the yen) are all but barfing up chunks of lung.
Large Caps Versus Small Caps
Back to the opening question – which countries (i.e. currencies) to buy? Now that we’ve established “none of the above” when it comes to the big boys, think about this.
Countries and companies have another similarity in that one can think of “large caps” versus “small caps.” By way of this analogy, the large cap currencies – i.e. the scrip of the big rich Western giants – are the ones we want to stay away from. The “small caps” are where the value is…
Take a country like Australia, for example. When one tallies up all the things Oz has going for it, “the lucky country” starts looking damned attractive. (They gave it that nickname for a reason.)
For starters, Australia’s economic recovery is no smoke-and-mirrors fluke. It is the real deal. That is a huge plus in comparison to the rest of the deeply indebted Western world, where painful deleveraging is a process that will most likely take years – not months, but years – to fully play out.
Second, Australia is blessed with prodigious natural resources… and a ravenous source of demand right next door. Not only does the lucky country possess vast quantities of the metals, minerals and various raw materials that Asia will want (and need) to buy in the coming years, it happens to be perfectly situated as a supplier.
Third, Australia’s balance sheet is attractive. Oz is not drowning in long-term debt, nor piling on additional debt like mad in an effort to buy itself out of a jam (as Japan has already done, the United States is currently doing, and the eurozone may soon be forced to do – if it doesn’t crack up first).
Hidden Assets on the Books
The other attractive thing about Australia – and other countries like it blessed with natural resources – is the nature of “hidden assets on the books.” Let me try to explain…
One time-tested value investing strategy is poring over balance sheets for the presence of hidden or undervalued assets, and then waiting for the market to recognize or “unlock” the true value of those assets.
For a true-to-life example, imagine coming across a company that has a few million acres of timberland buried in its list of current assets. For quirky accounting reasons, one might find that this timberland is being carried on the books not at present day value, i.e. 2010 prices, but instead at 1982 prices, i.e. prices paid in the year the acreage was acquired. This actually happens a lot… and sometimes management does it on purpose, to give insiders the chance to accumulate shares more cheaply.
When a situation like this arises – and again, it happens more often than one might think – a savvy value investor will recognize that the company is actually worth far more than Wall Street is giving it credit for, because such-and-such an asset is “hidden on the books” at a far lower recorded price than present day value would reflect. Sometimes the discrepancy between recorded value and present value is so great, it becomes possible to buy in for less than the dollars-per-share value of the tangible asset itself… and get a profitable business thrown in for free!
Your editor is reminded of this “hidden assets on the books” strategy when he considers all those hard assets and raw materials that countries like Australia, Canada, Norway and the like have locked away in the ground.
After all… if we expect the major fiat currencies of the West to turn into confetti longer term, then what is going to happen to the price of highly desirable resources like oil and copper and uranium and gold? If we further expect Asia to boom in the long run, how much more attractive will those hard assets become? And, in turn, how will investors value the prospect of countries sitting on huge stores of the very same – locked in the ground and “hidden on the books” as it were?
Countries That Pass Muster
Going over the sound investment criteria laid out at the beginning of this piece, a clearer picture now begins to form.
In terms of which countries to invest in (by way of currencies as shares of stock), we want nations with decent management (or at least competent management) and not too much debt. An abundance of natural resources (“hidden assets on the books”), ample long-term growth prospects, and positive cash flow (i.e. positive trade balance) would also be good.
To relieve the suspense, Taipan has actually come up with a list of such countries that fit the bill. They are as follows:
• Australia
• Hong Kong
• Canada
• New Zealand
• Norway
• Singapore
Australia and Canada are the hard asset kings, and have more or less avoided the global financial crisis. While their fortunes are inextricably linked to hard assets, this will be a huge advantage in the years to come.
Norway is one of the richest countries in the world, and vastly rich in oil resources to boot.
Hong Kong and Singapore are rich in connections, entrepreneurial dynamism and human capital, with Hong Kong a gateway to China, and Singapore in strong bid to become the “Switzerland of Asia.”
New Zealand is one of the most beautiful resource-rich countries in the world, with prospects similar to next-door-neighbor Australia.
Why Better Than Gold?
Why, you ask, would these “greenback alternatives” be considered better than gold? Because gold, as attractive as it is, does not offer a direct return on investment (other than potential capital gain).
Don’t get me wrong here. Everyone should have solid exposure to gold, and the outlook for the yellow metal is still quite attractive over the long haul. The Achilles’ heel of gold as an investment, though, is that it doesn’t pay dividends or offer a yield of any kind… and it doesn’t do much in times of prosperity and growth.
From a purely financial standpoint, gold is insurance against the folly of men – and that is as it should be. Gold is in a bull market now because folly is high and rising. But juxtaposed as it is against the crumbling foundations of a rotten system, gold is more a form of insurance than a bet on the future. And dumb as he can be at times, man still has enough ingenuity and heart and innovation up his sleeve to make permanently betting against him an unwise choice.
The virtue of small-cap currencies backed by countries rich in hard assets and growth prospects, then, is the opportunity to do well both in good times and bad. As the fortunes of the West go into decline – and the dollar, euro and yen look more shaky by the day – the more stable, less indebted small-cap currencies of select countries look more valuable.
Nor are we the only ones to have noticed. Consider this from the Financial Times:
Russia’s central bank announced on Wednesday that it had started buying Canadian dollars and securities in a bid to diversify its foreign exchange reserves.
Analysts said the move could be a sign of increased diversification of emerging market central bank assets away from the dollar and into investments denominated in other commodity-linked currencies, such as the Australian dollar.
An Easy Way to Diversify
Taipan is nothing if not proactive. And that’s why you’ll be pleased to know there is an easy way to diversify out of U.S. dollars… and into a basket of yield-producing currencies from the countries listed above.
It’s called the EverBank Ultra Resource Index CD. The CD is available from EverBank in three- and six-month terms, and offers exposure to currencies of Australia, Hong Kong, Canada, New Zealand, Norway and Singapore (the same countries as mentioned above).
Coincidence? No. EverBank created this CD at the specific request of the Taipan Publishing Group. We wanted to come up with a simple, easy way to diversify out of greenbacks without hassle or headache.
And in contrast to the aggressive Forex trading services Taipan offers (like Currency Profits Trader), in working with EverBank we sought a currency product more suited to a long-term investment point of view.
Obviously, your editor is somewhat biased. He has been an accountholder with EverBank for some years now, and writes to you as a satisfied customer. The Taipan Publishing Group also receives a small commission from the sale of EverBank products (which would be logical, particularly as we requested this one).
But given the above, the case for the “small cap” currencies seems clear – as does the intrinsic value of what EverBank has to offer. If you want to find out more about the Ultra Resource Index CD, you can do so here.
Warm Regards,
JL
About the Author: Justice Litle is the Editorial Director of Taipan Publishing Group, Editor of Justice
Litle’s Macro Trader and Managing Editor to the free investing and trading
e-letter Taipan Daily. His articles have been featured in Futures magazine; he
has been quoted in The Wall Street Journal and contributed regular market
commentary to Reuters and Dow Jones.