Merk: Opportunity In China; Still Bullish On Euro

October 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, California. 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 the different policy options of the Federal Reserve, the Bank of Japan the European Central Bank and the effect those policies will have on their respective currencies. Merk wraps up with his outlook for emerging markets. More than ever, it seems Europe and the U.S. are headed in different directions in terms of monetary policy and economic growth. Is that how you see it?
Axel Merk: Yes, but in different ways from which the market appears to see it. What people don't realize is that real interest rates in the U.S.—interest rates after inflation—are more negative in the U.S. than they are in Europe, and the gap has been widening and the gap is expected to widen further. In fact, even if we had a very hawkish Fed, and we had the federal funds rate at 1.75 percent at the end of 2015, real interest rates would be more negative in the U.S. than in Europe.

Having said that, obviously the market is right in the sense that the trajectory has been a more hawkish one at the Fed. And in particular, ECB President Draghi has been trying to be convincingly irrational and has been trying to talk down the euro, and has been trying to convince the market that rates in the eurozone are going to be lower for longer. And how much success do you think he'll have with that? How do you see the ECB's actions affecting the value of the euro over the coming months?
Merk: As you may recall in the past when I've talked to you, I've been really positive about the euro. The one thing I cautioned about is a surge in volatility. Now, at the time, I did not anticipate that one of the sources of that volatility would be the ECB itself with its policies. What has happened in the eurozone is that because of Draghi throwing in the kitchen sink, so to speak, the euro bulls—including us—stepped aside. And with that, the bears had a free reign to drive down the euro.

What has to be kept in mind though is that when it comes to money printing, the announcement is more important, as far as the marketing factor is concerned; it's more important than the actual buying of securities. He's made all these announcements, but on the follow-through, he's going to have a very tough time. The reason he's going to have a very tough time is because there aren't any asset-backed securities for him to buy.

There's really nothing wrong in the covered bond markets; banks don't often hold them. And then on the liquidity provision, on the refinancing operation, the uptick has been rather lukewarm. And so when it comes to action, I don't think he can do so much.

So the question is only, when are they both going to come back into the arena? And one encouraging sign to anybody who likes to see the euro higher, is that when German data were rather weak, the euro actually bounced a little bit. And so, short term, it appears that the euro has found the bottom. You touched on equity volatility there, and we've definitely seen a return of volatility to equity markets. Do you think the volatility will lead to a flight to safety that could half the yen's slide?
Merk: We watch correlations very closely in these markets. And the one thing that was very particular about the second quarter was that the dollar was rising on the back of a rising equity market. The assumption is that when there's a "flight to safety," there's a dollar benefit. But at least in the early part of October, that has not been the case. When the market has sold off, the dollar has also sold off.

So don't count on the traditional safe havens providing the safety net that you're looking for; there is no place to hide. As far as the yen is concerned, it has had a terrible couple of months. And clearly there can be a pullback in the yen. Having said that, on a fundamental basis, as you may know, our price target for the yen is infinity; meaning, we don't think the yen can ultimately survive that. Now, clearly, in the short term, that doesn't mean it cannot regain some of these characteristics when we have a really strong sell-off that the yen can benefit.

So yes, in the short term, if we have a sharper sell-off in the stock market—which we very much anticipate—we think that the yen can provide a little bit of a buffer, but on a longer-term basis, we think that the yen is to be avoided.

For example, something we've cautioned about for some years already is that Mr. Abe is going to double down. And the most recent announcement that the stadium that they're building is going to cost about $1.7 billion shows that the government is willing to do anything to stimulate economic growth. You build stadiums or you ramp up military spending. You do the Keynesian thing where you try to spend money no matter what the cost is.

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