Asset Inflation and Dollar Devaluation

No, I didn't come up with that gem of a title. It's direct from Todd Harrison of Minyanville. His working hypothesis has been that stocks and commodities go up when the dollar goes down, and, vice versa. It's working beautifully since the previous bear-market bottom in 2002-2003.

Anyway, the US Dollar Index continues to drip below the multi-decade support level of 80, being particularly weak against the Aussie (FXA), Euro (FXE), Loonie (FXC) and the Brazilian Real (BZF). The Aussie in particular is up nearly 30% since the March lows, nearly equaling returns in the equity markets.

The best markets have nearly doubled off their March lows, including the Emerging Markets (EEM), China (FXA), Brazil (EWZ), Russia (RSX) and India (IFN). Even developed markets in Australia (EWA) have had huge runs. Individual commodity stocks such as Freeport (FCX) have tripled off their lows.

It's been a heck of a run off the early March lows. Personally, you can't chase here. The charts look very similar: over bought, extended, with RSI (14) in the 70s. Discipline dictates waiting for the inevitable pull back to relieve over bought conditions. This correction should result in some mild dollar strength, commodity weakness, and consolidation at these levels for the various markets.

I have commented previously about the high correlation between the increasing strength of foreign currencies, commodity prices, and stock prices. They have continued to all go up together. For the speculator or trader or investor the question is one of "beta" vs. risk.

For example, I'm long one of the most conservative ways to play this trend, the US dollar bearish fund (UDN), which may increase a fraction of a percent on a day like today. Meanwhile, the CRB commodity index was up 3%, as were the major market averages. Oil did particularly well too, which I am long (DBO).

I am overweight in gold (GLD) and silver (SLV) which didn't move today, which is not surprising given how overbought they are, short term, and the suspicion by many that there is central bank or IMF selling holding gold below the key $1000 level. However, silver was equally flat. Base metals like copper continue to run big on presumed Chinese stock piling and improving news on the Chinese economy.

There is hope that news from the developed world including the US, Europe, Japan, etc is "less bad." However, all things considered it appears Australia has the best combination of economic policy, economic strength, and exposure to Chinese demand. The only "stock" I am long is EEM, but on a pull back I would like to add exposure to Australia (EWA), and may increase my holdings of the Aussie (FXA).

The mechanics of the US markets include a pronounced absence of selling pressure, under-invested hedge funds and other money managers who now are forced to chase performance, versus technical resistance at the "key" 950 level on the SPX. A weekly close above 950 would suggest a bottom is in place and a new bull market has truly started.

At that time, I would allocate some capital into index positions such as SPY, QQQQ, or IWM on a pull back.

Disclosure: long FXA, FXE, UDN, GLD, SLV, DBO, EEM, and BZF.

Comments

[Alan Young:]

Very good article. I appreciate the clarity, and the immediate usefulness of investment ideas.

Jun 02 10:20 AM

[user396040:]

I generally agree. A decline in the dollar normally reflects decreased anxiety on the part of international investors. It also automatically increase the earnings of US companies with foreign operations as the foreign currency earnings are valued higher in dollar denominated terms. It also helps US companies export and compete against imports. A way to look at it is that companies have a bunch of assets and an ability to generate earnings (some of which are in dollars and some of which are in foreign currencies) - when the value of the dollar declines, it makes sense that it will take more dollars to buy that bunch of assets and earnings generating capacity.

Jun 02 01:43 PM

[RiskReturnO...:]

Don't forget DBV, especially after the June 15th rebalancing. Might provide new opportunities for continued strength in the carry trade. The risk-reward for DBV is not bad for more conservative investors who might be scared away by the volatility of FXA (dollar volatility).

Jun 02 02:21 PM

[The Geoffster:]

Good rebuttal to this:
globaleconomicanalysis...

Jun 02 09:07 PM

[BGRT:]

While I'm in the camp that investors are overly pessimistic about the dollar and that gold at >$1000 is beyond any reasonable fundamental valuation, relative to AUD CAD and especially CNY, the USD has a bit to fall. I don't give much weight to GBP EUR and JPY since they have their own problems to deal with, but they can be a good diversifier. I'm not particularly worried about the USD falling due to the too much supply, I believe the Fed has enough tools to control this. Instead, the aforementioned currencies will rise relative to the USD due to increased demand, combined with relative financial stability of these countries. The absence of financial stability is what rules out other currencies such as BRL and ZAR in my books though.

Jun 03 02:42 AM

[Dr. O:]

Today we had a 1%+ counter-trend rally in the dollar, with a 3% decline in various commodities, particularly oil, gold, silver, and natural gas. Likewise, the commodity currencies like the Brazilian Real, the Canadian Loonie, and the Australian Aussie declined a couple percent each.

As I noted just yesterday in the article above, all these charts were over-bought, with daily RSI 14s in the 70s. We'll give the dollar it's rally from DXY 78 or so, up a few percent, allowing the USD to work off some over-sold conditions, and the foreign currencies and commodities to work off over bought conditions.

That should take a few days to a week or so, then it's time to step back in and reload FXA, FXC, BZF, SLV, and GLD. If EWZ or other BRICS come down enough, they're a buy too. But after the March rally I'm more inclined toward wealth preservation through currency conversion and precious metals than I am to chase return by buying ETFs up 50-100% from their March lows.

Jun 03 08:15 PM

[llcsc:]

I was told by my broker that I lose the hedging against the dollar opportunity by investing in foreign ETFs like BWZ, WIP, JGT, and PHB because they all use American Depository Receipts (ADRs) which are denominated in dollars and cancel out any benefits we might receive from a devalued dollar. Is this true???

Nov 10 11:01 AM