Merk Likes Euro, Sterling & Gold Miners

July 14, 2014

Axel Merk is considered one of the top currency experts in the industry. He is president and chief investment officer of Merk Investments, based out of Palo Alto, Calif. Merk is the manager of the Merk mutual funds, including his flagship Merk Hard Currency Fund. He recently launched the Merk Gold Trust, a deliverable gold ETF. Merk is a regular on CNBC and Bloomberg TV, and the author of "Sustainable Wealth."

Merk recently sat down with to discuss his concerns around low forex volatility and the ECB's latest round of stimulus. He also tells us his current top currency picks and his thoughts on the bitcoin ETF filing. Forex volatility is at record lows. What do you make of this low volatility in the currency markets, and does it concern you?
AXEL MERK: The low volatility in all markets, including the foreign exchange markets, does concern me. It signals complacency. We have scared away many investors in the foreign exchange markets. We have scared away many of the big players. Many hedge funds have left that business. Many banks are less able to trade their own book. All of that means there is a potential for less liquidity. It also means people might be caught off guard at some point when volatility comes back. What's causing this low volatility, especially in the currency markets?
Merk: All kinds of things. First of all, Dodd-Frank and other regulations have pushed some players out of the market. That's the first reason. The second reason is that a lot of folks who have had systematic trading strategies have not made money in recent years. That has caused some exit. Then the central banks around the world that are working very hard to keep volatility low have contributed as well.

All of that spills over to general complacency across investors. That's probably my biggest concern. That's obviously the final driver then why volatility is very low in foreign exchange markets, as well as in some other markets. What are your favorite currencies against the U.S. dollar for the remainder of the year?
Merk: That's a good question. We often like to mention the euro, simply because everybody always loves to talk down the euro. The European Central Bank is talking down the euro so much. Having said that, while we are positive on the euro versus the dollar, we think the sterling will outperform the dollar.

At the other end of the world, we think the Australian dollar, which has been held back quite substantially, should benefit quite a bit from the sea of liquidity that should continue to be around; also because we think China is going to do much better than many people expect. On that note, while the currency is not historically as volatile, we do like the renminbi as well. The ECB just unleashed a round of unconventional stimulus measures to which the currency hasn't reacted much to, at least not yet. What moves do you expect from the ECB next?
Merk: Let's put this into context. The reason the euro hasn't reacted much is because negative deposit rates don't really matter when there are no deposits left. It's a negative rate on deposits at the ECB. Those deposits are just about depleted.

Secondly, the new initiative that has been taken, I have no idea why they should be negative for the euro. First of all, it will be a long time before they'll be implemented. Secondly, if indeed credit growth is being stimulated, that should be a net positive for the euro.

The one thing that is a negative for the euro is that Draghi has promised to keep rates lower for longer. That's a medium-term negative, but at the same time, I don't expect really much from the ECB. They have to do their homework. They have to learn to be patient.

The biggest project they have is to streamline regulation in the banking system and to help those banks to clean up their balance sheets. Those things don't happen overnight. They are at work and they're making progress, but that's a long and steady project that they are undertaking. Do you expect the ECB to eventually engage in outright quantitative easing, or outright eurozone bond purchases?
Merk: What they have announced so far—they call it a TLTRO—is really just yet another liquidity facility. Any project that wasn't worth financing at a fraction of a percentage point is now a couple basis points cheaper. So it makes you wonder whether that's really going to make the difference.

Secondly, the outright purchases that some people are talking about—I have no idea what they're supposed to be achieving. The yields in the eurozone are extremely low. I don't know what benefit a tad lower yield should do. In the weaker eurozone countries, yields have already plunged from 6, 7, 8 percent to sometimes 2 percent.

That is an amazing stimulus. So, I don't quite know what outright purchase should achieve, other than grabbing some headlines. Keep in mind also that there will be very strong resistance to outright purchase from the Northern European countries. As such, I think yes it's possible.

But the odds of outright purchases happening are very, very low. For the time being, Draghi is buying time with all these initiatives he's undertaken. They'll need to show some results for it. So any next steps are going to be a far way off on them. Yesterday [7/8/14], Samsung gave poor guidance, claiming the strong Korean won is eating into its profits. Do you have a view on the won, and do you expect currency intervention there?
Merk: The Korean Central Bank is one of the more volatile central banks. First of all, people should be aware that Korea is one of the more liquid markets. So whenever money goes into Asia, it goes to Korea first. Conversely, it leaves Korea first. The Korean government can turn on a dime. Whenever these fears come up, you see a U-turn in policy. So anything can happen, from a policymaking point of view.

The broader problem is twofold, though. Everybody is printing money. So the folks who print a little bit less tend to have a strong currency, and conversely, global demand is not there. Samsung is a poster child for that. Everybody has a smartphone these days.

The next big thing, we're all hoping that Apple is going to invent it, but don't bet on that happening. We have an economy that's making progress. But we do not have gangbuster growth around the world. That's not going to change. It's not going to change with a weaker won either. Turning to Korea's main exporting competitor, we're seeing stronger-than-expected inflation numbers coming out of Japan. The Bank of Japan is making bold statements that it's going to hit its 2 percent inflation target. Does this delay or even scrap your previous calls for further easing by the BOJ?
Merk: We let the market tell the story. Whenever the yen behaves as a "safe haven," our view is that the policies are not being effective. When the yen is not rallying on bad news, that to us suggests they're "making progress" and slowly but surely eroding confidence in the yen.

For the time being, yes they have inflation. But they have it in all the places where they don't really need it—in food and energy, most notably. They have made some progress. At first glance, it appears that their consumption tax hike has been stomached by the markets, but I would not draw any conclusions at this stage.

The key challenge still is that structural reform is extremely difficult. While there are some good initiatives such as increasing the number of women working in the workforce,it's going to be very difficult to change those things. In the meantime, the debt in Japan keeps piling up, as progress is very, very slow.

I continue to believe that the biggest threat Japan is facing is that they're actually succeeding. Once they're succeeding, bonds will fall, and it's going to make it impossible to finance their deficit.

As long as we're in this muddle-through environment, the Japanese are going to be just fine. Sometimes we take a tactical long position on the yen, but generally speaking, in the long run, we are still very bearish on the yen. We don't think the yen is going to survive this. Why are JGB yields continuing to fall in the face of these higher inflation numbers?
Merk:The Bank of Japan is printing a great deal of money. They are hoping to boost real economic growth. But instead, what's happening is that investors are just buying JGBs with that. It's as simple as that. Everybody is just recycling the money into JGBs and with that, the yields—for the time being—stay low.

That's one of the reasons we prefer to short currency rather than to short bonds. In Japan at least, it's cheap to short bonds. But it's a very dangerous game to short bonds in general. Shorting a currency is, generally speaking, the more cost-effective way to express a negative long-term view on bonds. Last quarter, you were optimistic on gold miners, which have performed very well since. Do you still hold that same view on gold miners?
Merk: Yes, because gold miners have finally focused on expenses. They were so desperate for growth, in addition to all stakeholders trying to get a bigger chunk when the boom times were there in the gold sector, that anybody who held gold mining stocks knew that it was extremely frustrating. We play gold directly most of the time rather than gold miners.

Still, on the gold mining sector, because costs are going to be under control more so than in the past, because there's a huge amount of pessimism in the market, we think that gold miners should do quite well going forward.

On a broader note, the reason we think gold miners and gold should do well going forward in the context of potentially rising rates is that we don't think real interest rates will be positive. We don't think we can afford positive interest rates in the U.S., in Japan or in the eurozone. You just launched a new gold ETF, ticker OUNZ. Tell us about the ETF and how it differs from current offerings like GLD and IAU.
Merk: OUNZ is a deliverable gold ETF. The key differentiator to the other gold ETFs in the market is that investors may be able to request delivery of the gold that they hold through OUNZ. Taking delivery of gold is not a tax event. You are merely taking delivery of what you already own. We don't expect that everybody is now going to buy their gold and have it delivered through the exchange. But we do believe people like to have that feature available.

If you like to buy an ETF now, but down the road you might want to take possession of the physical gold, with the other gold ETFs, you'd have to sell it and then go and buy a coin. What we can do, while we hold London bars in London—like the other ETFs do—at the time you request delivery, we can do an exchange into other coins. So you can have 1-oz. coins delivered to your home. There's now a bitcoin ETF in filing. What are your thoughts on bitcoin? Do you see it as a legitimate alternative currency?
Merk: It's a technological phenomenon that's rather fascinating. A currency it is not. It actually turns out that as an ETF, they are addressing many of the concerns people have. The bitcoin community is always trying to stay out of the regulatory environment, which is impossible, of course, if you are successful.

The key challenge bitcoin has always had is anti-money-laundering concerns. The regulators would like to know who owns this, and so forth. Once you have an ETF, you have to buy it through your brokerage account. All these concerns have fallen by the wayside.

Having said that, I am not so convinced that market makers will want to touch it. Conversely, it would be very beneficial to the bitcoin community if market makers were engaged, because then, finally, you have a hedging market that's developing, and that's something that's very much been missing in that market. INSIGHT

CurrencyShares British Pound Sterling (FXB | B-99)
Merk previously noted that investors were caught off guard when Bank of England Governor Mark Carney wasn't as dovish as expected. Positive economic data has sidelined Carney, and with the U.K. economy humming along, Merk currently favors the pound sterling as one of the currencies most likely to appreciate relative to the U.S. dollar. FXB is a stable, liquid ETF providing exposure to the GBP/USD currency cross that Merk expects to appreciate. The fund's $75 million in assets is modest, but it trades more than $1 million most days at 2 basis point spreads. FXB is structured as a grantor trust, and all gains from the sale of shares are taxed as ordinary income.

CurrencyShares Australian Dollar (FXA | A-99)
Merk singled out the Australian dollar as one of his top currency picks for the remainder of the year. He believes the Chinese economy will surprise on the upside, benefiting the Aussie dollar because commodity-hungry China is Australia's largest trading partner. FXA shares are physically backed by Aussie dollars, so it's an excellent way to gain "pure" exposure to the AUD/USD cross. The Aussie dollar is one of the few developed-market currencies with a meaningful yield, so FXA shareholders enjoy roughly a 2 percent yield (2.5 percent local interest rate minus 0.40 percent expense ratio). The $295 million fund trades with robust liquidity—$4.2 million a day at 3 basis point spreads—keeping trading costs low. Structured as a grantor trust, all gains and distributions are taxed as ordinary income. Alpha Think Tank ETF Tracker

Methodology: ETF selections are made solely by They are neither selected by, nor are they investment recommendations from, Alpha Think Tank strategists. ETF selections are made by the Analytics team based on the themes highlighted in each weekly interview with Alpha Think Tank strategists.

We implement a stop-loss of 10% from the Pick Date, whereby any funds triggered by that stop will drop off the tracker. The tracker data is updated weekly and is subject to change, according to our ongoing interviews with our strategists.

Ticker Fund Name Pick Date TR % (Since Pick Date) TR %
(1 Yr)
Closing Price $ (7/11/14) Inspired By
INDA iShares MSCI India 2/24/14 21.91 23.67 29.39 Roubini
EWW iShares MSCI Mexico Capped 3/3/14 16.48 6.77 69.08 Friedman
GDX Market Vectors Gold Miners 3/31/14 15.74 10.44 27.32 Merk
AMU ETRACS Alerian MLP ETN 1/27/14 15.60 16.68 32.52 Luskin
PXH PowerShares FTSE RAFI Emerging Markets 2/17/14 14.55 15.36 21.81 Arnott
CCXE WisdomTree Commodity Country Equity 3/14/14 14.05 16.99 32.27 Schiff
GXC SPDR S&P China 2/3/14 11.50 17.45 76.53 Rogers
EWP iShares MSCI Spain Capped 1/27/14 10.92 45.50 41.28 Luskin
DBB PowerShares DB Base Metals 5/8/14 9.80 5.05 17.48 Gartman
RSX Market Vectors Russia 2/3/14 9.75 4.17 26.79 Rogers
EWW iShares MSCI Mexico Capped 2/11/14 9.71 6.77 69.08 Fitzsimmons
EWI iShares MSCI Italy Capped 1/27/14 9.60 39.28 16.84 Luskin
INDA iShares MSCI India 4/9/14 8.81 23.67 29.39 Kotok
MCHI iShares MSCI China 4/15/14 7.67 14.32 47.42 Faber
ELD WisdomTree Emerging Markets Local Debt 2/17/14 7.59 3.42 47.77 Arnott
NKY Maxis Nikkei 225 2/3/14 7.54 2.66 17.70 Rogers
IEMG iShares Core MSCI Emerging Markets 4/28/14 7.24 13.93 52.45 Luskin
GMF SPDR S&P Emerging Asia Pacific 4/9/14 6.80 14.88 84.10 Kotok
EWY iShares MSCI South Korea Capped 2/24/14 6.19 17.63 63.96 Roubini
EWJ iShares MSCI Japan 3/3/14 6.01 1.94 11.94 Friedman
VTI Vanguard Total Stock Market 4/28/14 5.66 19.67 101.74 Luskin
RSP Guggenheim S&P 500 Equal Weight 3/10/14 5.13 21.14 76.57 Dorsey
EWP iShares MSCI Spain Capped 2/24/14 5.05 45.50 41.28 Roubini
FXA CurrencyShares Australian Dollar 3/14/14 4.66 4.09 93.97 Schiff
ERUS iShares MSCI Russia Capped 5/22/14 4.64 2.19 20.56 Arnott
BKF iShares MSCI BRIC 5/22/14 4.30 14.97 39.19 Arnott
GULF WisdomTree Middle East Dividend 3/10/14 4.12 31.39 22.57 Dorsey
EWH iShares MSCI Hong Kong 4/15/14 3.94 14.38 21.09 Faber
FXC CurrencyShares Canadian Dollar Trust 3/14/14 3.46 -3.02 92.64 Schiff
BAB PowerShares Build America Bond 4/9/14 3.43 10.35 29.41 Kotok
EWP iShares MSCI Spain Capped 3/10/14 3.13 45.50 41.28 Dorsey
XLU Utilities Select SPDR 4/9/14 3.12 15.38 42.83 Kotok
EWS iShares MSCI Singapore 5/5/14 2.38 6.09 13.74 Bremmer
EIDO iShares MSCI Indonesia 5/28/14 2.25 -5.35 28.62 Fitzsimmons
VNM Market Vectors Vietnam 4/15/14 2.24 16.65 21.20 Faber
DBJP db X-trackers MSCI Japan Hedged Equity 6/12/14 2.07 3.99 36.37 Roubini
EPOL iShares MSCI Poland Capped 3/3/14 1.92 17.89 29.14 Friedman
CHIQ Global X China Consumer 3/17/14 1.83 6.85 14.50 Yardeni
IEMG iShares Core MSCI Emerging Markets 6/12/14 1.54 13.93 52.45 Roubini
VTI Vanguard Total Stock Market 6/10/14 0.80 19.67 101.74 Friedman
ROBO Robo-Stox Global Robotics and Automation 3/3/14 0.71 N/A 27.15 Friedman
SCPB SPDR Barclays Short Term Corporate Bond 3/17/14 0.41 1.90 30.76 Yardeni
KOL Market Vectors Coal 5/8/14 0.22 3.93 18.56 Gartman
AFK Market Vectors Africa 5/5/14 0.12 19.65 33.16 Bremmer
USDU WisdomTree Bloomberg US Dollar Bullish 4/15/14 -0.65 N/A 24.64 Faber
VIS Vanguard Industrials 7/2/14 -0.80 22.48 103.81 Yardeni
DBC PowerShares DB Commodity Tracking 3/14/14 -1.08 -1.19 25.75 Schiff
VHT Vanguard Health Care 7/2/14 -1.22 25.87 112.42 Yardeni
FXE CurrencyShares Euro 3/31/14 -1.32 3.44 134.24 Merk
DBGR db X-trackers MSCI Germany Hedged Equity 2/24/14 -1.35 18.22 25.42 Roubini
DBC PowerShares DB Commodity Tracking 3/31/14 -1.42 -1.19 25.75 Merk
EWL iShares MSCI Switzerland 6/24/14 -1.53 15.80 33.84 Dorsey
CHIQ Global X China Consumer 2/11/14 -2.09 6.85 14.50 Fitzsimmons
ITA iShares U.S. Aerospace & Defense 5/5/14 -2.34 25.89 107.10 Bremmer
IAU iShares Gold Trust 3/14/14 -3.21 3.84 12.97 Schiff
EZU iShares MSCI EMU 6/12/14 -3.65 23.77 41.17 Roubini
TUR iShares MSCI Turkey 6/10/14 -4.61 1.84 56.34 Friedman

Data as of 7/11/14


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