Monday, April 7, 2008

The Merk Hard Currency Fund

A few years ago I began my email struggle with the US government and financial media (CNBC, Barron's, Business Week, etc. etc) with respect to my concerns about peak oil and its potential impact on the US economy and equity markets. I was for the most part ignored. Of the responses I did receive, my favorite was from Joe Kernen at CNBC who basically called me an idiot doomsayer. When I emailed Kernan back last year to remind him that I called $100/barrel 3 years earlier, he brushed me off saying it was all "speculation" and that we should be getting 2 barrels of oil for the current price. That was big progress for Joe - his new target ($50/barrel) was a doubling of his earlier call. Slowly but surely he's moving and I suspect he'll get to $100/barrel when oil trades at $200/barrel. But I digress.
The point is, I realized that the US government and media were in complete denial about peak oil. Combined with the Republican's idiotic fiscal, tax, foreign, and trade policies I could only come to one conclusion: the US dollar was heading down and inflation would be heading up. From an investor's point of view, I began looking for alternatives to US dollar investments for my "cash". CD's and US bonds would be dead money in the coming years. Think about it, a CD yielding 4%year while the US dollar drops 7%/year and real inflation is at least 5%, and you are losing 8%, and that's before taxes! Jeez.
I soon found out it was very difficult to find cost effective ways to invest in non-US dollar denominated cash instruments. What was needed was a way to buy Euro, Swiss, or Australian denominated CD's where one could get some yield and also get a kicker from a weak US dollar. I was surprised how hard such a simple strategy was to put in action.
The Prudent Global Income Fund [PSAFX] was one solution. PSAFX primarily invests in securities issued by major industrialized nations with sound economic and financial systems. It also invests in equity securities of companies that mine gold. The fund attempts to capitalize on currency fluctuations by investing in securities issued by governments whose currency the Adviser believes will appreciate in relative value. Performance wise, the fund was up 6.8% in turbulent Q1 2008, and was up 16.9% in the last 12 months, far outpacing the S&P 500's performance. Good action. This fund was a great way for me to hedge against weak US policy and US currency.
Another fund meeting the same objectives was the Merk Hard Currency Fund [MERKX]. I was really happy to find this fund as it too was exactly what I was looking for. It invests in a basket of hard currency denominated investments composed of high-quality, short-term money market instruments of countries pursuing sound monetary policy, and indirectly in gold. The fund invests indirectly in gold through ETFs, forward and futures contracts. Just what the doctor ordered. MERKX was up 7.0% for Q1 2008, and was up 20.3% in the last year. Again, far out-pacing the S&P 500.
So far so good, but I have a bone to pick with the MERK Hard Currency Fund. Early last year I noticed MERKX did not have a position in the Chinese yuan amongst its top-10 positions. I thought this was very odd. Renowned investor Jim Rogers was very bullish on China and moved his family to Singapore to be closer to the action. The Chinese economy was and is growing at a double-digit pace and governments around the world were clamoring for the Chinese government to allow their currency to float (strengthen). Even the Chinese themselves were making noise about the unsustainability of the huge US trade deficits and their own internal inflation rates. A bet on the Chinese yuan seemed like a no brainer to me. But I'm just an engineer, what do I know about economics?
So, I went to the MERK website and sent them an email with my suggestion they add the yuan to their top-10 holdings and rationalizing why this would their fund an even better performer. To my delight (and considerable shock), I got a response within minutes from non other than Axel Merk himself. Mr Merk is an extremely intelligent fellow, and any US investor would be well served by reading his insights on:

That said, Axel's response was somewhat disappointing. The yuan was not an "appropriate investment for the Hard Currency Fund" because the trading vehicles did not exist and another objection with respect to forward contracts of both a deliverable and non-deliverable type. Ok, I was over my head here...however, I wrote back and said something to the effect of "hey, come on Axel, there has to be a way to add the yuan to the fund - make it happen!" Well, it never did happen.
You can then imagine my great surprise when Merk recently announced the new "Merk Asian Currency Fund" including the Chinese yuan (!?). Hmmm.....if Axel could find a way to add the Chinese yuan to the new fund, how come he could not find a way to add the currency to the "old" Merk Hard Currency Fund? Of course I fired off another email and got a similar response to the first email with the added recommendation that I buy the new fund to diversify. My response was that I wanted the diversification in the MERKX fund that I already own! I may indeed buy some of the new Asian fund, but why can't I have the added diversity of the Chinese Yuan in my existing positions in the Merk Hard Currency Fund. After all, that is exactly the funds objective as you state on the MERK website!
Regardless, investors can make up their own minds. Both the Merk Hard Currency Fund and the Prudent Global Income Fund are good US dollar hedges. That said, there are those out there who believe the US dollar will strengthen once the Federal Reserve gets to the end of their interest rate cuts. It may well do that, with some foreign help (i.e. massive currency intervention). However, the fundamental weaknesses of the US economy, its extreme exposure to high oil prices, and the disastrous fiscal and tax policies put in place by the Bush administration require, in my opinion, an insurance policy. These two funds are just like a good neighbor.

Disclosure: I own long positions in both MERKX and PSAFX. The performance data mentioned in the article were obtained by the Wall Street Journal's recent Q1 2008 report, April 3, 2008.

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