Why Now's the Time to Bet on the Dollar

 @ibtimes
on December 16 2009 3:41 PM

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I'm not normally much for big predictions, but this one is a no-brainer: The U.S. dollar is going to skyrocket sometime in 2010, which is huge news for your portfolio...

I know that prediction seems to go against everything you've read in the Sleuth in the past. But I assure you it makes perfect sense...

Before investors lose faith in the dollar, they'll lose faith in everything else. Think of the value of the dollar as one kid on a seesaw and investments (stocks, funds and bonds) as the other kid.

When the stock market and bonds both rise, the dollar falls. That is what 2009 was all about.

But as investors rip their investments out of stocks and bonds, they're essentially buying the dollar - jacking up the value.

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The Second Peak Is Already Here

Our economy is about to relapse from the disease that sent us into the Great Depression: Part Deux.

In the first half of the past decade, subprime loans were king. They were cheap and easy to get approved. Along with the subprime boom came subprime adjustable-rate mortgages (ARMs), which were equally easy to afford...for a while.

Of course, the A and the R in ARM meant that the interest rate borrowers pay changes, or resets. The majority of these resets occurred between the summer of 2007 and the summer of 2008.

This period saw a massive amount of mortgage interest rate hikes, which caused millions of foreclosures. Things spiraled down from there, eventually freezing nearly all credit and causing the panic of 2008.

Of course, that's the 50-cent version of recent history. There were plenty of other financial calamities that went along with this, including the bundling of mortgage-backed securities and risky derivative products.

If you believe the Obama White House and the glass-half-full press corps, you think this mess is now behind us. We are, after all, in a recovery...right?

Unfortunately, no one is talking about the second wave of ARM resets and foreclosures...

You see, this second wave will come crashing even harder than the first. It's made up of a type of mortgage called option ARMs. These give borrowers the option of how much they want to pay during the first five or 10 years of repayment:

  1. The full amortized rate, including interest and principal.
  2. Full interest only, or...
  3. A teaser rate, well below the amount needed to cover the interest on the loan.

This third option puts borrowers into even more debt than when they signed for the house. This can lead to mortgages amortizing up to 125% of their original balance.

After the rates reset, they can jump upward of 6% or 7%. That's hundreds, and even thousands, of dollars in expenses unaware homeowners could incur in a month's time.

Obviously, these option ARMs were supposed to be reserved for customers with better credit than those who took out subprime mortgages. But apparently, they were handed out to anyone who wanted them.

According to Whitney Tilson and Glenn Tongue of T2 Partners, the experts on this subject, about 80% of option ARMs are negatively amortizing. Meaning these so-called top-tier borrowers are heading further into the hole. Once their rates reset, they could be in serious trouble.

And that could be happening very soon:

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The chart above shows the two peaks in this long-term housing conundrum. The first mountain is comprised of subprime ARM resets. And the second is mostly constructed of option ARM resets. We appear to be in the eye of the storm.

That alone shook our nerves when we first discovered it. But it was a different chart in Tilson and Tongue's most recent presentation that really got us startled...It's also the reason I'm predicting the dollar spike in 2010.

Instead of resetting as expected after the first five years, many option ARMs are so negatively amortized that they are hitting their automatic reset cap.

That means they are resetting early...like right now.

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As you can see from the second chart, the expected reset peak was to occur in 2011. But the real peak is happening now. You can also see that the amount of mortgages resetting is spread over a longer period of time than originally thought, but is peaking much earlier. Unfortunately, it's not the peaks that matter.

You see, those are just resets. But with unemployment reaching quarter-century highs every month, and the massive number of homeowners about to receive mortgage bills for two-three times what they are used to paying, we find ourselves in an even scarier environment than this time last year.

It takes anywhere between three-12 months for most homes to actually go into foreclosure. It's tough to say exactly when the storm will come. But my guess is the second half of this year.

None of this is meant to frighten you into moving. But it does give us a little look at what to expect.

When this next domino tips too far, we'll have quite a mess on our hands.

As Assets Fall, Everyone Buys the Dollar

Stocks will collapse - possibly even further than the last time. High-yielding bonds - which are up about 56% from last year - will also lose the faith of their speculative investors. Even gold - which is at its all-time high - will fall temporarily.

When investors sell all these assets, they essentially buy cash. Or at least that's where they will be storing their wealth. And while it is still the world's reserve currency, the U.S. dollar should take off.

That's exactly what happened last time.

As you can see in the above chart, the dollar index - which compares the U.S. dollar to a basket of other currencies - took off in September and October 2008...right when markets worldwide tanked.

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Who knows what this time will bring?

Of course, this boom in the dollar and fall in equities may not be the best news for our portfolios in the short term, but in the long term this is a great opportunity for investors who choose to prepare their financials for 2010. Naturally, I've already filled my Lifetime Income Report readers in on the best course of action (which you can learn more about by clicking here), but there are plenty of ways to play this one.

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