Taking Stock / Dry Your Tears, Speculator

When Zadik Bino told us a year ago that the dollar would sink to NIS 4.5 within months, we thought he was crazy, or trying to be original. Back then, the dollar was trading as high as NIS 4.9, and not a single analyst or banker was talking about the greenback falling all the way to its level of some 18 months earlier.

As always, the "experts" generally predicted that the shekel would depreciate by another 2-5 percent. Only the brave dared mention the possibility of a tiny appreciation.

Nobody expected the shekel could strengthen against the dollar by 10 percent in the space of six months.

Naturally, Bino knew perfectly well how dangerous it was to make predictions about the currency market; so at the time, he asked not to be quoted. One wonders how he handled his investment portfolios; as they are all privately held, however, we can't know.

But most investors aren't Zadik Bino; and even the savviest of sages belly-flops from time to time when forecasting currency trends.

It is easy enough to explain the shekel-dollar rates of three months ago - that's no great feat. As for the present, the main reason the shekel has surged so strongly against the dollar is frighteningly simple: Interest on the shekel is 8 percent, while interest on the dollar is less than 2 percent. Moreover, some depositors get no interest at all on dollar investments. This means that to hold dollars is very expensive. The interest differentials cost investors in dollars 6-7 percent a year.

Yet the above explanation is silly. Three months ago, the gap between shekel and dollar interest was even wider. So, what has changed?

The answer is the risk associated with Israel. With the war in Iraq over, and the U.S. increasingly involved in the region, forcing its road map on the parties and coming up with $9 billion in loan guarantees, Israel looks more like an American-sponsored state than even before.

Even though the government's deficit is expected to exceed 5 percent this year, the finance minister and his economic program are telling the markets that macroeconomic policy management has become more responsible.

The timing of the drop in Israel's risk factor was fantastic. International investors had just begun to scurry around the world looking for intriguing bonds granting better interest than the miserable rates that safer governments - those of the U.S. and the EU countries - were offering.

Almost every country beating the interest on the dollar saw an influx of foreign money in the last half year, resulting in appreciation of the local currency.

The same happened in Israel. The most prominent sign of the trend was Deutsche Bank's report on the Israeli bond market, the first in the market's history. Titled "Israel: Buy Long Term Debt", the analysts recommended purchasing Shahar 2012 bonds.

Take a tip

Here's a tip for you. If Deutsche Bank's analysts deem this the time to publish a colorful, impressive report recommending the purchase of Israeli government bonds, it probably means the bank has been buying them for itself and for its clients for several weeks already.

Indeed, Bank of Israel governor David Klein disclosed last week that foreign investors had purchased half a billion shekels worth of Israeli government bonds between February and April. They were joined, of course, by local investors, and Israeli government bonds soared 10-20 percent and more. The conversion of dollars into shekels to effect the purchases sent the dollar sliding down in the local marketplace.

The foreign investors did not settle only for bonds. They also bought heavily on the Tel Aviv Stock Exchange, as is evident by the soaring share prices of banks Hapoalim and Leumi, which foreigners view as excellent vehicles through which to gamble on the local economy.

Meanwhile, something that people don't necessarily notice happened. The dollar crashed against the euro, thereby automatically affecting its rate against the shekel. Note that while the shekel rose 8 percent against the dollar from the start of 2003, it gained only 4.5 percent against the currency basket. The missing parameter is that against the euro, it sank. The European currency strengthened by 4.3 percent against the shekel.

Naturally, every day the shekel gained more ground put added pressure on investors who had raced to buy dollars last year, to hedge against then finance minister Silvan Shalom and the catastrophic scenarios making the rounds about the approaching war with Iraq, the tremendous deficit, and the government's macroeconomic mistakes.

Now, the investors are slowly breaking, as fear of financial crisis evaporates. They are returning to the warm embrace of Klein's interest rates on the shekel.

But if you happen to have embraced the dollar last year, and are now losing hair from mortification and frustration as the shekel merrily clambers skywards, our tip is to relax. Not even the experts with the latest red-hot information on the currency market and Israeli economy predicted such a sharp U-turn by the dollar.

In Klein's inflation report published on January 29, 2003, the Bank of Israel analysts broke with custom and offered a clear hint about their opinion of the currency market. "Analysis of forecasts on long-term activity on the currency market indicates that in 2003, the underlying circumstances support depreciation of the exchange rate," they wrote. Since that day, the shekel has appreciated against the dollar by 12 percent.