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November 06, 2006

The Dollar May Fall After the Election
by Axel Merk

Making short-term predictions about the dollar is notoriously difficult. So why do we say the dollar may fall after the election? Once we know what the future composition of Congress will be, the markets can shift focus from the excitement of the moment to what may lie ahead.

We believe we have just seen the beginning of a more pronounced slowdown that will likely push us into recession. The reason why we are more negative than many economists is that high levels of consumer debt make the economy much more interest rate sensitive than in past economic cycles. An area where this is particularly apparent is in the housing market, as consumers in this so-called ownership society have massive levels of debt accumulated in their homes. Given that only short-term interest rates have risen, only the most speculative homeowners with adjustable rate mortgages should have been affected. But in a world where the speculators have driven up prices, the speculators are also dragging the entire market down with them as the housing bubble deflates. If and when long-term rates reflect that we may be heading into an inflationary or stagflationary environment, the fallout for the housing market could be severe as higher long-term rates squeeze masses of homeowners who need to refinance their mortgages in the months and years ahead.

For now, market commentators try to grab on to every bit of good news released. The "best" news seems to come from corporations that are involved in the option backdating scandals: these companies do not report their balance sheet while they investigate their wrongdoings. Wall Street loves them as revenue is the only reliable number released - and our executives have become experts as generating top-line growth. Indeed, in recent months, just about any piece of news has been interpreted as good news by the markets. Even in a perfect world, it is time to get very concerned about such exuberance. But the world is not perfect: when retail stores have same-store sales increases behind the rate of inflation, when hourly wages rise at a rate higher than economic growth, we have all the hallmarks of stagflation.

Remember those who were touting to buy stocks at the top of the dot-com bubble? Remember those who said there is nothing to fear from the housing market only earlier this year? These are the same pundits who called the top of the commodity boom this summer. It turns out that while the economy is slowing down, oil is about 50% higher than two years ago, gold is again above $600 an ounce, base metals hover once again near their highs.

Investors have been distracted from the big picture. And this is where the election may play a pivotal role. None of our challenges have gone away; but we now are faced with an economy that may slide into recession. The best news about the new composition in Congress is likely to be that it will get less done, which means that politicians can spend less. But just as equity and bond markets have priced in perfection, investors have also given more confidence to the dollar than it may deserve. Then again, many investors are not aware of just how much the dollar has weakened. Here is a chart of the Dollar Index, which reflects the movements of the dollar versus a basket of currencies:

If you avoided the fall in the dollar, your purchasing power would be much stronger now. This year, the dollar has resumed its downward trend that was interrupted in 2005. As long as the US economy focused on growth rather than savings and investments, this trend may continue.

When we say the dollar may weaken after the election, we know as little as anyone what will happen to the dollar in the days that follow the election. But we believe that the focus will shift to what is ahead. Given that timing currency moves is incredibly difficult, investors may want to consider taking a long-term approach by broadly diversifying into a basket of hard currencies; with hard currencies, we are referring to those currencies backed by sound monetary policy. Please visit www.merkfund.com for more details on what a hard currency is.

We manage the Merk Hard Currency Fund, a fund that seeks to profit from a potential decline in the dollar. To learn more about the Fund, or to subscribe to our free newsletter, please visit www.merkfund.com.

Axel Merk
Axel Merk is Manager of the Merk Hard Currency Fund

The Merk Hard Currency Fund is a no-load mutual fund that invests in a basket of hard currencies from countries with strong monetary policies assembled to protect against the depreciation of the U.S. dollar relative to other currencies. The Fund may serve as a valuable diversification component as it seeks to protect against a decline in the dollar while potentially mitigating stock market, credit and interest risks - with the ease of investing in a mutual fund.

The Fund may be appropriate for you if you are pursuing a long-term goal with a hard currency component to your portfolio; are willing to tolerate the risks associated with investments in foreign currencies; or are looking for a way to potentially mitigate downside risk in or profit from a secular bear market. For more information on the Fund and to download a prospectus, please visit www.merkfund.com.

Investors should consider the investment objectives, risks and charges and expenses of the Merk Hard Currency Fund carefully before investing. This and other information is in the prospectus, a copy of which may be obtained by visiting the Funds website at www.merkfund.com or calling 866-MERK FUND. Please read the prospectus carefully before you invest.

The Fund primarily invests in foreign currencies and as such, changes in currency exchange rates will affect the value of what the Fund owns and the price of the Funds shares. Investing in foreign instruments bears a greater risk than investing in domestic instruments for reasons such as volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. The Fund is subject to interest rate risk which is the risk that debt securities in the Fund's portfolio will decline in value because of increases in market interest rates. As a non-diversified fund, the Fund will be subject to more investment risk and potential for volatility than a diversified fund because its portfolio may, at times, focus on a limited number of issuers. The Fund may also invest in derivative securities which can be volatile and involve various types and degrees of risk. For a more complete discussion of these and other Fund risks please refer to the Fund's prospectus. Foreside Fund Services, LLC, distributor.

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