How Investors Can Trade the Dollar

It is well established that gold and the US dollar are inversely correlated. This rule of thumb is not often broken and traders who hold their free funds in foreign currencies can benefit from that. The dollar has been trending down for months now and last week we saw some gains in the dollar index. Gold, consequently, was down. What if you could benefit from the fall in gold and from the rise in the dollar (compared to other major currencies) at the same time? Well, for non-US traders it's actually quite simple.

I am not a resident of the US, therefore, I don't keep a large amount of my portfolio in dollars to limit my losses from a possible fall in the dollar compared to the euro (which the Estonian kroon is pegged to). When I see a possible trade, I first buy dollars and then buy the stocks. For me and other traders who use the same strategy, the combination of a rising dollar and falling gold prices is very lucrative, because it allows us to benefit from a rise in one asset and a fall in a currency at the same time.

The way to benefit from this is to buy dollar denominated stocks that are inversely correlated to gold. For people with less risk appetite, PowerShares DB Gold Short ETN (DGZ) should be enough. For traders with more risk appetite and knowledge there is the PowerShares DB Gold Double Short ETN (DZZ). Before trading the latter, make sure you know what a 'double short' means. There are plenty of articles on Seeking Alpha about leveraged ETFs.

The chart below is a mirror image of GLD and DGZ, which is more than enough to prove the inverse correlation. Keep in mind that the performance of DZZ is way more erratic!

Interestingly enough, when gold prices rise and the dollar falls, us foreign traders will not gain anything by trading ETFs like GLD or DGP because the fall in the US dollar nets out the profit.

Disclosure: No positions at time of writing.

Comments

[arlin:]

I think the dollar is going to put in a higher low and then move higher to .95.....over the next two years.........with almost everybody bearish on the dollar,and all the news of "other global currencies" trying to come to fruition,I feel this move in the dollar would cause the most pain.also the Chinese are long term players,and In my opinion a stronger dollar would be what they are supporting,while they can divest some of the trillions of their own currency/labor manipulation.(in fact they're buying into hedge funds now,so they can gain some control of all the manipulation)The Euro is also at some strong resistance....(and remember they are in terrible shape as well).I also remember that during the market sell-off when banks and brokers were going under the dollar went higher(less debt/margin)
I think that gold is going to go lower first,and then move higher with the dollar.The huge inverse head and shoulder on gold targets 1300 area.
Ultimately the dollar tanks,but not for a while.

Jun 21 09:09 AM

[yellowhoard:]

Playing the dollar is like playing Russian Roulette with three bullets in the gun.

There are too many black swans lurking out there for my comfort.

And, there are just too many other ways to make money these days without having to stand on the railroad tracks.

Jun 21 09:29 AM

[retiredengi...:]

too much leverage for me. Each time the exchange allows more tricks the further away it gets from the fundamentals. Until there is some sence, cents, in the market I'll stay away.

Jun 21 10:41 AM

[esotericist:]

the correlation is NOT 'well-established'. Look at the charts.

Jun 21 01:22 PM

[change is t...:]

Kristjan you may be onto something. For non-US traders, you are talking about an arbitrage on dollar owners going back and forth (or long and short) with gold. Other (single) currencies will not witness (or even HAVE) this happen as acutely as they may not individually have a global exposure to trade. (Gold is the only real OTHER global currency). If you are right about this relationship (even as a reliable rule of thumb that is not 100% perfect), US equity traders (with dividends or options) can use it too. If you are right, it would be better to consistiently switch cash reserves or short one, buy the other.....as a contrarian...who knows they will switch back. If you are right, this is extremely valueable and not hard to do. As long as there is fear the dollar will fall, this trade tatic will work. Rather than bet on gold or the dollar, bet on the switch. I had not thought of that. Thanks.

Jun 21 04:25 PM

[Kristjan Ve...:]

arlin:
I'm not suggesting which way the dollar will move next, I was just pointing out a trade idea.

yellowhoard:
You are right about that to a certain degree. The best example would be next week - we have a lot of news coming out and I can honestly say that I don't have the slightest idea where the news is going to take us in terms of EURUSD. BUT, then again, when the news is out and the USDX has an establised trendline, you can make some money.

retiredengineer:
Well, the trade I pointed out is not like walking on a minefield or anything. However, if you don't feel comfortable with technical analysis, I completely understand you. It's good to see that some people have the sense to keep away from the stuff they don't feel comfortable with.

esotericist:
What chart are you looking at?

change is the only constant:
Glad I could help. Switch trades are actually quite interesting. I've heard that you can make switch trades between gold and silver at goldmoney.com, but I don't know if that's true (I don't have an account there). Gold and silver constantly change ratios and that would be an interesting pair to trade, as far as I'm concerned.

Jun 21 04:44 PM

[Kristjan Ve...:]

I did look at the charts. The correlation IS obvious. You don't need to be Sherlock to crack this one.
USD Index vs. gold = www.sharelynx.com/char...

On Jun 21 01:22 PM esotericist wrote:

> the correlation is NOT 'well-established'. Look at the charts.

Jun 21 05:05 PM

[Northstar10000:]

You still have to pick whether the dollar is going up or down. Charts currently show gold Strong Dollar weak. That still does not tell you what trade to put on. If you want to say the most hurt would come from a move up in the dollar you have to take into account what that would mean for other classes of assets. It's not as simple as it seems. The fed wants a weaker dollar but does not want higher interest rates. The china folks want a strong dollar. Currency traders just want to turn a buck. who wins short term is the forces most powerful at the moment when significant news can move a market in their direction. I bet on gold here. I am in line with the feds and at odds with the bond and china folks. Pick you spot someone will be right. Just remember the charts are useless right here.

Jun 21 05:52 PM

[Kristjan Ve...:]

Look at the last two weeks - it was a perfect setting for this kind of trade. I wrote this article to shed light on a possible trade setting. Of course, this trade window is not open all of the time, but when it is, it offers significant profits. Dollar looks strong from a technical perspective, especially when considering the dollar index. By strong I mean that it has gone down way too fast and needs to correct that move (i.e. pull up a bit) before heading down again. But, of course, I can't predict what effect the FOMC meeting or other news releases will have next week.

Charts are not useless if you consider the monetary/fiscal stimulus data, the COT data and so forth. Having blind trust in charts and Fibonacci retracements alone is what gets you into trouble.

Jun 21 06:29 PM

[Tom Oz:]

I agree with your outlook as I am a non US resident also. DGZ provides a double benefit when gold is falling in price. Do you have a strategy to benefit from a rise in gold price for non US residents?

Jun 21 07:00 PM

[Kristjan Ve...:]

That's fairly obvious, isn't it? Buy the miners. Of course, you will not be able to secure yourself from a fall in the dollar when buying stock on the US markets, if that's what you mean. But you can always buy Canadian or even Australian miners on their respective exchanges. Their currencies usually go up when the dollar falls and commodities rise because so much of their production is related to commodities. When you do trade the miners, prefer the ones with the highest % of income from gold sales (big companies like Rio Tinto and BHP mine gold as well, but it's only a small percentage of their sales and therefore a rise in gold prices won't have much effect on it's share price).
PS! DGZ only provides a double 'benefit' intraday! It doesn't follow price movements in the long term.

I hope I didn't oversimplify things for you. I just want to make things clear because there are a lot of people here who are new to investing/trading (I presume you are one of them) and I know I would've appreciated if someone explained me all the little details back when I was new to the game.

On Jun 21 07:00 PM Tom Oz wrote:

> I agree with your outlook as I am a non US resident also. DGZ provides
> a double benefit when gold is falling in price. Do you have a strategy
> to benefit from a rise in gold price for non US residents?

Jun 21 07:38 PM

[buyforeclos...:]

With the printing of huge amounts of dollars logically the currency is falling. But then you have to wonder, who is going to start printing money next? If consumers around the world don't spend/buy then my guess is every country ( with the exception of those with great balance sheets ) will have no choice but to print money as stimulus. And if that happens suddenly the balance sheets are not looking so great based on the GDP . So I am naturally dollar bearish but at the same time another market crash and hints of further stimulus from emerging markets and other major players could very well send the dollar up 10-15% ... However, if we truly are in recovery mode and those green shoots are not mirages, the Dollar is in for some pain.
I laugh because the FED is trying to stimulate the economy but seems to forget the Dollars correlation with oil and consumer spending. If consumer spending is 2/3rds of GDP, and all this printing of money is raising oil prices and thus gasoline prices, then how exactly is the average American going to have extra money to spend on non discretionary items? I know I am not looking to buy a car anytime soon even with fantastic deals...nor am I looking at new shoes or a TV or computer or golf clubs...... all of which their prices have fallen to enticing levels. I have to worry about having money in the bank in case I lose my job or if things are slow for a protracted amount of time...and I think most people here in the US are in my camp. Green shoots? I just don't see them . not yet anyway..maybe we will in 2010..that is my hope anyway.But even if we do I will be frugal at least the next 2 years as will most of the people I speak with. GL people .

Jun 21 09:26 PM

[buyforeclos...:]

Author..... the problem with RIO and BHP is their stock prices have soared due to China stockpiling... the question is when China is done buying ( and they may already be finished ) WHO is going to carry those companies? The shippers got KILLED last week on these concerns. I would have to wait for better entry into those stocks as I know the weak dollar and China has given them moonshots but I am not sure they can sustain those levels anymore....the last week or so has shown alot of money moving out of commodities due to China concern... In the LONG run? Sure you have to like them. But nobody knows how long this recession is going to last stimulus or not....which makes getting into these plays at current levels riskier than I like...I know they will come back but don't want dead money for any lengthy period of time... I think Oil may hang tough for summer but it may head back to 50's after peak driving if the dollar doesn't get trampled in the next month or 2....GL

Jun 21 09:33 PM

[Peter Cooper:]

The gold chart looks ready to take-off right now, have a look:
arabianmoney.net/2009/.../

Jun 22 02:26 AM

[Doc 224899:]

Kristjan,

A good gold miner stock will leverage the gold market, and may be more predictable and more profitable than a double long gold ETF. It takes a little study, and it helps if one can hold one's breath for more than 60 seconds, but the miners are where leverage can be found outside the ETFs.

Having played this game for the last couple of years, I'd say it is useful to remember that gold swings in and out of being tied to the dollar, to global currencies, to oil, to treasuries, and to broad market indices. It also changes faces and one month it will be a safe haven in a crashing market, and next month it will be tied to strong commodities. It also wears three hats at once sometimes. Finally, it is also subject to behind-the-scenes manipulation, and to "legitimate" regulation by central banks and the commodities exchange(s).

Jun 22 08:21 AM

[Dean M:]

I try to focus on shippers of gold used in technology applications

Jun 22 11:25 PM