The Dollar's Long Term Trend Appears to Be Set in Stone

One who has imagination without learning has wings without feet.

Joseph Joubert

1754-1824, French Moralist

The Chinese by nature are very respectful when addressed by leaders and therefore, what occurred a few weeks ago when Treasury secretary Geithner addressed the students at the prestigious Peking University is very telling.

"Chinese assets are very safe," Geithner said in response to a question after a speech at Peking University, where he studied Chinese as a student in the 1980s.

His answer drew loud laughter from his student audience, reflecting scepticism in China about the wisdom of a developing country accumulating a vast stockpile of foreign reserves instead of spending the money to raise living standards at home. Full story

The fact that these students laughed loudly clearly indicates that the Chinese have no faith that the US government is concerned with preserving the value of the dollar. As of March China had 786 billion dollars invested in treasuries. As we have repeatedly stated in the past, the Chinese are very advanced chess players and what makes them even more formidable is their capacity to be extremely patient. China basically controls the US now, and those that control the strings of the purse control the nation. If China threatens to sell its treasury holdings it would literally break the bond market and drive interest rates to record levels in a matter of days.

While the above story is a good measure of the dollar's long term demise, it is not accurate in terms of its short to intermediate term direction. There is a very good chance that the dollar could actually go on to test its 2008 Oct-Nov highs, and possibly even put in a new high. The testing of its old highs will mark the beginning of the end for the dollar; from there it could lose up to 60% of its value before it stabilises, which means commodity prices will literally explode across the board.

However, for this short term scenario to remain valid, the dollar cannot trade below 78 for more than 3-4 days in a row; if it does then the chances of it rallying to new highs will have diminished significantly. The dollar traded as low as 78.35 and then immediately rallied from these levels; this is a good initial sign for it shows that the 78 price point level is a zone of strong support. The rally we are expecting in the dollar coincides very nicely with the rally that is set to occur in the bond markets; when individuals purchase bonds, they are indirectly opening up long positions in the dollar (in other words, they are buying the dollar). As with the bond market we are expecting the dollar to put in its final high in the next 6-12 months and then embark on a long down trend that could result in a total loss of up to 60% of its former value.

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As long as the Dollar does not close below 78 for more than 3 days in a row the outlook will remain bullish; ideally, it should not trade below its June lows of 78.35. It initially mounted a rally but then shed most of those gains and is now attempting to rally again. It needs to trade past 82.50 for roughly 3 days in a row and penetrate down trend line in the 1 year chart; a break past this level for 3 days in a row should be enough to propel the dollar all the way to the 85.50-86.00 ranges. If the dollar breaks below 78.00, the next target becomes 74, and it will also suggest that the downward slide in the dollar is occurring at a faster rate than was initially projected. The current pattern calls for a rally that should lead to a test of its recent highs or potentially to new 52 week high before it embarks on a long downward journey.

www.stockcharts.com

The 2 year chart confirms the outlook of the 1 year chart. To move higher the dollar needs to trade past its main down trend line, which falls roughly in the 82.50-83.00 ranges, and a break below 78 would take it at the very least down to the 74 ranges. In the 2 year chart, we notice how important the 78 price point level is; it's a zone of support that stretches back almost 2 years and thus a break below this level would be a very decisive move.

The dollar still has time to move higher and the action in the bond markets is suggesting that it should move higher as the bond markets appear to have put in an intermediate bottom that could result in them rallying for up to 9 months and thus a rally in the bond markets should drive the dollar higher.

We are not expecting the dollar to mount another long term rally; this rally will be the last strong rally for sometime to come. Once this rally is over (current targets are now in the 88-90 ranges, but it could rally as high as 92), we expect the dollar to resume its long term down trend and shed up to 60% of its value. As long as the dollar can remain above 78 the picture will remain somewhat bullish, a close above 82.50 for 3 days in a row or a weekly close above 83 will turn the hourly, daily, and maybe even the weekly trends bullish.

One rather strong bullish factor for the dollar is the fact that when it traded to new 6 moth lows, gold did not respond by trading to new highs; this is a rather strong intra market negative divergence signal and usually such signals indicate that the weaker market (in this instance the weaker market is the dollar) is going to mount a rally.

Risk takers could deploy funds into the dollar now with the intention of closing these positions out the moment the dollar tests its old highs and then redeploying this money back into their original currencies. There are many ways to take advantage of this situation, the riskier ones will yield significantly higher returns but the simplest strategy would be to purchase shares in the ETF UUP.

The current pattern indicates that the Dollar could trade to the 90-92 ranges; this represents roughly a 15% gain from current levels; in currency markets such moves are considered massive.

'Tis but an hour ago since it was nine, and after one hour more twill be eleven. And so from hour to hour we ripe and ripe, and then from hour to hour we rot and rot. and thereby hangs a tale.

William Shakespeare

1564-1616, British Poet, Playwright, Actor

Disclosure: We have no position in UUP but are looking into opening up positions in the very near future as soon as one indicators generate one more buy signal.

Comments

[DONE_SONZ:]

How much would a bankrupt currency be worth?Sorry to say"saving" won't bring us out of this mess.Without an economic recovery,it"s more doom and gloom.

Jun 28 07:54 AM

[the.bighouse:]

One thing the Founding Fathers fortunately built into our system of government is flexibility, both politically and economically, and the ability to change course faster than most societies and governments on the planet. So Mr. Palha tell the Chinese students not to laugh too soon and don't underestimate the ability of change in our government. NOTHING is set in stone (a good American proverb) in the USA except perhaps to change economic course more quickly than China or most other countries. Just ask the Japanese who thought they owned America in the late 1980s.

Jun 28 08:45 AM

[George Kesa...:]

You all foget how bad things are on the other side.

@the.bighouse, I second that

Jun 28 08:56 AM

[Long Silver...:]

Isn't the focus on currency indices as a predictor of the future like looking at a car's speedometer to try to determine future speed? It seems like one needs to focus on what's under the hood (the engine and how many pulleys, etc. are putting a load on the motor) and the terrain, as well as how other cars are doing in the race?

Jun 28 09:10 AM

[CLH:]

The dollar has gone up and down. What are you looking at--- the last few weeks of the dollars value? That means nothing.

Watch gold --it topped March 2008 and is now dead in the water.

Jun 28 12:29 PM

[cmoore90638:]

You have to look at what wold happen on both sides. the US can't live without china, and China can't live without the US. If they devalue the dollar. it will be hard for them to sell to The US. in the end the two sides will find a negotiated settelment

Jun 28 05:43 PM

[kiers:]

china is surreptitiously being compensated as we speak. but u won't catch it in the "news"! they sit on UN security council, can't be sanctioned.

they own the US till the US is weaned off of debt. fat chance!

no it won't be a negotiated settlement. they have punitive power, in that they can dump SOME holdings to change long term rates. by being so tied to the global reserve ccy, the yuan is ALSO a reserve currency. what power! they too can print unlimited yuan debts and buy whatever is required. no one to answer to.

Jun 29 12:48 AM