Last week, the European Central Bank abandoned all pretense that the euro would be the worthy heir of the Deutsche mark; based on the enormity of the nearly $1 trillion bailout of Greece and the moral hazard it creates for other spendthrift member-states, the euro is instead on its way to becoming the worthy heir of the drachma. While the bailout was intended to restore calm to the continent, thereby strengthening the euro, the result is a currency that has lost its shot at glory. Like Terry Malloy... it coulda been a contender.

Prior to this bailout, many investors – myself included – held to the belief that the German-led eurozone would be more fiscally responsible than countries whose governments have unilateral control over their own currencies. Given the decentralized political structure of the eurozone and the independence of the ECB, it was assumed that Western Europe would be unlikely, and perhaps unable, to inflate its way out of debt. As a result of this assumption, Europeans have enjoyed low interest rates and favorable exchange rates since the euro's introduction.  

However, many member-states, Greece first among them, abused the borrowing privileges conferred by a strong currency and, to put it bluntly, bit off more than they could chew. Rather than allowing Greece to default, which would have put real teeth into Europe’s previously untested commitment to fiscal responsibility, Europe proved it was all bark and no bite. The net effect has been to demonstrate that the ECB will monetize the debts of any member-state that has borrowed too much. As this understanding sinks in around the globe, the euro just sinks.

Unfortunately, many are mistaking this euro weakness for dollar strength. A quick glance at the price of gold – which has made new highs in both currencies – quickly disproves this myth. The fact is that both the dollar and the euro are losing value. At the moment, the euro is losing value faster; however, in the race to the bottom, my money is still on the dollar to win.

It is generally believed that the US government will never default on its debt, no matter how much red ink it generates nor how onerous servicing that debt might become. For now, the rest of the world seems content to buy our debt – despite the fact that they are paid next to nothing for the favor. To those who have raised concerns that foreign buying may someday cease, the Fed has clearly telegraphed its intention to print as much money as needed to buy up any debt that remains unsold. Under these conditions, those who now question the future validity of the euro without casting similar warnings on the dollar are employing a shameless double standard.

For all of its new faults, the euro remains more reliable than the dollar. Once the re-rating process is complete, and the euro finds a new floor, I expect the dollar to resume its relative slide against its transatlantic cousin. Meanwhile, I expect both currencies to continue to lose value relative to gold and other key currencies. Given the euro’s damaged reputation, I expect pledges from European governments to rein in budget deficits and from the ECB to defend the value of its currency. While the long-term implementation of such commitments may prove lacking, a short-term rally in the euro should ensue – especially given the rapidity of its recent descent, and the overwhelming bearish sentiment against it. It is my intent to use such strength as an opportunity to re-evaluate our eurozone holdings. 

While we have been underweight the euro for years, as I long saw the potential for this dire scenario, we may well decrease its weighting even further. If I am wrong about a near-term rally, and the euro continues in free fall, there is a risk that the eurozone will be redefined. Either the heavily indebted nations will be forced out, or a political revolt in the more fiscally responsible nations will end the bailouts, causing the indebted to pull out voluntarily. Either way, such a development might be a boon for investments in those nations that remain in a leaner eurozone, and possibly for those that exit to embrace fiscal responsibility on their own terms.

For now, the most interesting aspect of the Greek bailout has been President Obama’s audacious lobbying in favor of it. He has become deeply involved in what is essentially an internal matter of the EU – demanding bailouts from Germany and lecturing Greece on fiscal responsibility. Aside from a penchant for irony, the President of the most indebted government on Earth is likely motivated by fear of a real-life sovereign default making headlines. By encouraging Europe to bail out holders of Greek and Portuguese debt, Obama hopes our creditors will sleep soundly as well. 

Had Greece been allowed to restructure, bondholders would have been forced to absorb real losses from a developed country for the first time in recent memory. That would have accelerated the current debate on sovereign debt, and led some investors to reevaluate all of their holdings. The last thing Washington wants is for holders of Treasuries to start taking a critical eye to its balance sheet. Under such scrutiny, global creditors might correctly conclude that it’s all Greek to them, and rerate our debt accordingly.

Peter Schiff is President and Chief Global Strategist of Euro Pacific Capital, a full service registered broker dealer that specializes in foreign securities, Member FINRA/SIPC. He is an expert in foreign securities markets as well as currency and gold markets. Mr. Schiff delivers lectures at major economic and investment conferences, and is quoted often in the print media, including the Wall Street Journal, New York Times, L.A. Times, Barron's, Business Week, Time and Fortune. His broadcast credits include regular guest appearances on CNBC, Fox Business, CNN, MSNBC, and Fox News Channel, as well as hosting a weekly radio show. He is also the author of two bestselling books: "Crash Proof: How to Profit from the Coming Economic Collapse" and "The Little Book of Bull Moves in Bear Markets".

Investment Ideas
Oil Patch Moves North

In light of the inflationary environment being teed up by the Fed’s relentless money printing, we feel commodity prices will continue their upward trend. As a result, we see opportunities in companies involved in petroleum production. In particular, we are focusing on firms working in the Bakken Formation, an expansive oil-producing region of North America.

The Bakken is part of the Williston Basin located in eastern Montana, western parts of North Dakota and South Dakota, and southern Saskatchewan. Identified by geologists in 1953, the field extends approximately 475 miles north-south and 300 miles east-west. Based on recent development of the Bakken field, only Texas, Alaska, and California currently produce more oil than North Dakota. (According to the Energy Information Agency, North Dakota had been ranked 8th among the states just three years ago). In 2008, the USGS (US Geological Survey) estimated the Bakken Formation had 3.0 to 4.3 billion barrels of undiscovered, recoverable oil – a 25-fold increase compared to the agency's 1995 estimate.

A key factor in North Dakota’s rise in oil production has been the advancement of a drilling technique known as ‘horizontal multistage fracturing.’ The Bakken Formation is two miles underground, and its oil is held in a fairly shallow horizontal layer. Extraction requires a two-mile deep conventional (vertical) well that turns 90 degrees for another two miles. Short segments of this horizontal section are then pumped with pressurized water to fracture the surrounding rock, allowing access to additional oil that would otherwise be unrecoverable. As a direct result of this technical innovation, North Dakota’s annual crude oil production has doubled since 2000. 

This activity has attracted oil services companies to help drill, fracture, transport, and refine the increasing amounts of oil gushing from the Bakken. Here are two that we like:

Company #1

North Dakota's production of 275,000 barrels per day (bpd) has nearly outpaced the state's refining and transportation capacity. The state's only refinery has a capacity of 58,000 bpd. This company's pipeline, which moves oil east, has recently expanded its capacity significantly. The company is a publicly-listed limited partnership headquartered in Texas, with over 4,000 miles of pipes in its system.

The company's stock price fell dramatically in the latter half of 2008, as fear drove the market heavily into cash. As activity returned to the energy patch, demand for pipelines resumed. The company raised its dividend after reporting solid improvement in net income for the first quarter compared to the same quarter last year.

The company's market capitalization is now almost $6.0 billion, with an attractive distribution.

Risks: Company A's performance may be affected by pipeline overcapacity, reduced oil production, availability of cheaper, alternative oil transport mechanisms, and/or any natural or manmade disruption to the pipeline. 

INTERNATIONAL INVESTING MAY NOT BE SUITABLE FOR ALL INVESTORS. 

CLICK HERE TO RECEIVE MORE INFORMATION ABOUT THIS COMPANY, AND SEE IF IT IS SUITABLE FOR YOUR INVESTMENT OBJECTIVES AND RISK TOLERANCE. OR CALL 1-800-727-7922 TO SPEAK TO AN INVESTMENT CONSULTANT.

Company #2

Company #2 provides consulting services and solutions for the process of hydraulic fracturing – a method of breaking through stone to reach oil pockets. It is also the world's largest supplier of an essential component in the fracturing process. As the rock surrounding the wellbore breaks as a result of pressurized water injections, this company's product wedges itself into the newly formed crevices. Without the product, the fractures could close and stop the flow of oil.

This Texas-based company has little debt and sells its oil production improvement and recovery services in North America, Europe, and China. The company reported increased year-over-year revenue and announced that it plans to increase its production capacity by 40% over the next 20 months.

The company's market capitalization is now approximately $1.5 billion, with a promising dividend yield.

Risks: Company B will suffer if demand for fracturing falls, if new technology displaces its technique, or if environmental regulations were to limit use of its product. 

INTERNATIONAL INVESTING MAY NOT BE SUITABLE FOR ALL INVESTORS. 

CLICK HERE TO RECEIVE MORE INFORMATION ABOUT THIS COMPANY, AND SEE IF IT IS SUITABLE FOR YOUR INVESTMENT OBJECTIVES AND RISK TOLERANCE. OR CALL 1-800-727-7922 TO SPEAK TO AN INVESTMENT CONSULTANT.

Disclosures

Yields will fluctuate based on market prices.

Euro Pacific Capital has been the lead in 2 private placements concerning oil production in the Bakken region. Euro Pacific Capital or one or more of its employees may have a position in these private placements.

Investing in foreign securities involves additional risks specific to international investing, such as currency fluctuation and political risks. There can be no guarantees of success in pursuing any of the strategies we recommend, or that any of the specific companies will gain in value. Risks include an economic slowdown, or worse, which would adversely impact economic growth, profits, and investment flows; a terrorist attack; any developments impeding globalization (protectionism); and currency volatility/weakness. While every effort has been made to assure that the accuracy of the material contained in this report is correct, Euro Pacific cannot be held liable for errors, omissions or inaccuracies. Euro Pacific has not independently verified the information supplied by the company, and cannot make any representations as to its accuracy. This material is for private use of the subscriber; it may not be reprinted without permission. The opinions provided in these articles are not intended as individual investment advice.

Guest Commentary
Don't Fret Over the Dollar Index
Andrew Schiff, Director of Communications

Many investors have come to rely on the movements of the "Dollar Index" as a daily barometer of the U.S. dollar's relative strength and weakness. Since most of the major financial news outlets also use the Index as their key dollar data point, it is not surprising that most people, including Euro Pacific investors, take it on faith that the Dollar Index is the dollar – pure and simple. In reality, the Index offers a very distortive view of the movement of the dollar against the currencies that matter most to the Euro Pacific investment approach. If anything, recent movements of the Index are a reflection of euro weakness rather than dollar strength.

The Dollar Index is a basket of six non-dollar countries/currency areas. Here's how the weighting breaks down: 

As you can see, the top three currencies account for more than 83% of the total composition, with the euro alone taking up more than half of the Index. Meanwhile, the eurozone only accounts for some 25% of non-US Gross World Product (GWP). The reason for this discrepancy is that the Index has not been rebalanced since its creation in 1973, when the "euro" portion was made up of the strong and separate currencies of West Germany, France, Italy, the Netherlands, and Belgium.

Euro Pacific clients may see little correlation between the currency composition of the Dollar Index and that of their investment holdings. This is no accident. We do not randomly select the currencies in which we invest. Instead, we examine key economic fundamentals in order to target economies whose underlying strength will have a positive impact on the performance of our investments.

Many of you realize that we take national fiscal discipline very seriously. The primary reason we continue to recommend investments in non-dollar assets is because we feel that the US government is pursuing policies that will ultimately destroy the value of our currency. Logically, we also avoid investing in foreign countries following the same path. Given that all politicians and central bankers are subject to the same inflationary temptations, it is incumbent on our strategy first to select those countries that have shown the strongest monetary self-control. Otherwise, we would be jumping from the frying pan straight into a fire.

A benchmark for our strategy is currently reflected in a product that has the following allocations: (breakdown by country; please check your portfolio's unique allocation before drawing any inferences)

Two noticeable differences in our allocation from that of the Dollar Index are the absence of the UK pound and the much lighter exposure to the euro.

Our weightings also differ from the Dollar Index in the much higher exposure we give to currencies from the "resource economies" of Australia, Canada, Norway, and Brazil, as well as our significant holdings in the Asian mercantile city-states of Hong Kong and Singapore. We are also notable in our light exposure to Japan, which has pursued programs of artificial stimulus and 'quantitative easing' like those of the United States.

The different weightings translate into very different outcomes over the long haul. For instance, in the two years between May 1, 2008 and April 15, 2010, the currencies in the U.S. Dollar Index (in the same weightings as in the Index) fell by 8.9% against the dollar. By contrast, over the same time frame, the investment in the regions we have selected (in the weightings listed above) fell by only 4.2%. If your Euro Pacific Capital account is allocated similarly to the regional breakdown above (please check your portfolio), that would have amounted to a 5% difference in performance. This is not a trifling sum.

As it turns out, there are empirical reasons to explain the divergence.

We have long felt that the European Union would one day come under intense conflict between its monetary union and the political independence of its member states. As a result, we have always been somewhat wary of euro-denominated investments.

The Greek debt drama has placed those tensions on vivid display. After months of tough talk from fiscally responsible Germany, the EU has recently yielded, pledging close to $1 trillion to bailout Greece and, in the process, giving a tacit guarantee to the debt of its other weak member-states. The bailout signifies Brussels' decision to parrot Washington's policy of "monetization" of bad debt. They are choosing inflation over default, paving the way for the euro and dollar to devalue contemporaneously – rendering the Dollar Index a deceptive indicator.

Meanwhile, the debt problems currently surfacing in the US exist in the UK to an even larger degree. As a result, the pound sterling, which does not have a reserve currency advantage like the US dollar, has been one of the weakest major currencies of the last few years. Despite the problems with the euro and the pound, we have nevertheless maintained an attraction to European investment overall. The continent retains strong trade balances, high productivity, globally competitive companies, and high savings rates. As a result, we have included some European exposure in our strategy – especially in higher performing, non-euro countries such as Norway and Switzerland.

The Royal Bank of Canada ranks all countries by what it terms "Sovereign Debt Risk," which is the likelihood that a country will be unable to repay its debts. In calculating its index, the bank looks at a country's debt and government spending obligations as a percentage of its GDP, as well as other factors such as current account surplus or deficit, foreign exchange reserves, net external debt, real GDP growth, and inflation.

Among the major countries that the bank tracks, some of the best performers (least likely to default) are Norway, Switzerland, Australia, New Zealand, and Canada. Some of the poorer performers (most likely to default) are EU members (Greece, Portugal Ireland, and Italy), Britain, and Japan.

It should be no surprise that fiscal and monetary discipline translate into currency strength. And while the US dollar has recently done well against the Dollar Index, we have demonstrated that this is really a hollow accomplishment. When measured against gold, a much better arbiter of currency strength, the dollar has fared decidedly poorer. The greenback has also been buttressed by the dollar's reserve status and foreign governments' persistent delusions about America's ability to repay its gargantuan debt. Once these factors give way, as we believe they surely must, then fundamentals will be all that matters. We believe our clients are in the right position to deal with this new era when the curtain finally descends on the old one.

In the meantime, if your Euro Pacific Capital account is similar to our regional allocation strategy outlined above, the performance of the Dollar Index may have less of an impact on your portfolio than you may have imagined.

The opinions provided in this article are not intended as individual investment advice. 

Opinions expressed are those of the writer. Past performance is no guarantee of future results.

Andrew Schiff is Euro Pacific's Director of Communications, an experienced investment consultant, and co-author of the newly released illustrated fable, “How an Economy Grows and Why It Crashes.”

Thoughts About Peter's New Book
How An Economy Grows and Why It Crashes

For those who would normally prefer to watch paint dry than delve into economic theory, Peter Schiff's new illustrated book, How an Economy Grows and Why It Crashes, offers an enjoyable introduction to the subject. With wit, humor, and over 150 original illustrations, Peter and Andrew Schiff offer an easy-to-understand story of fish, nets, savings, lending, trade, job creation, and inflation. The allegorical tale of a small, primitive, island nation discusses the roots of economic growth and the reasons why economies decline.

Click here to learn more about this exciting new release.

Watch an animated introduction to How An Economy Grows and Why It Crashes:

Euro Pacific In the News
Recent Articles in which Peter Schiff was interviewed or quoted:

Upcoming Appearances
Upcoming conferences and seminars at which Peter Schiff is a featured Speaker. Click here for more information.

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