Looking for Signs of a Dollar Rally

Long-time readers know that I’ve begun to develop a love/hate relationship with the US Dollar. On the one hand, I believe the US currency is horribly flawed given our unserviceable debt load and the Fed’s profligate spending.

However, on the other hand, to make money investing you have to be willing to go against the crowd. And, with less than 3% of investors currently bullish on the US Dollar, the contrarian in me can’t help but wonder if we have the makings of a serious Dollar rally similar to the one that kicked off the 2008 crash in stocks.

Thanks to Ben Bernanke and pals, the US Dollar has essentially become the carry trade for the entire world. If you’re unfamiliar with “carry trades,” these are investment strategies in which you borrow in one currency (usually one with very low interest rates like the Dollar today) and invest in another currency or investment class of higher returns. Provided the second investment returns substantially more than interest rate on the currency you’re borrowing in, this can be a highly profitable strategy.

With interest rates at 0.25% or so today, the US Dollar has become the carry trade of choice, with investors all over the world borrowing in Dollars and investing in stocks, gold, oil; virtually any investment class you can name. The end result is that the Dollar has begun to trade at a near perfect inverse relationship to pretty much everything out there.

Carry trades work fine until the currency you borrow in rallies (or suddenly interest rates go up). When this happens the profit margin disappears and the trade often reverses as investors sell the second investment in order to pay back the money they borrowed.

This may be happening to the US Dollar right now. Last week, the Dollar rallied strongly as stocks, commodities (everything but gold), collapsed. The question now is whether this was the start of a genuine Dollar rally or simply a brief head-fake before the US currency rolls over to test its 30-year low of 72.

From a technical standpoint, the Dollar failed to break its 50-ema. Until this happens, the US currency remains in a downtrend.

However, it’s worth noting that the Dollar held its ground at 76 and change. Previously, 76 was a point of downward resistance. The fact that the Dollar rallied above this level and held it is a sign of increased strength. If the US Dollar holds here we may in fact be seeing the first signs of a rally in the US Dollar. If this happens, expect to see stocks and commodities (with perhaps the exception of Gold) completely collapse in a repeat of the second half of 2008.

Long term, I believe the US Dollar is a horribly flawed currency. The US has absolutely no way of paying back the debts it owes. And we’ve now spent more money battling the Financial Crisis than we did in WWI, WWII, and the New Deal combined.

However, with so much of the investor world betting on a Dollar collapse, the stage is set for a major surprise here. Even a brief bounce in the Dollar could become a full-fledged rally as shorts and other investors who are borrowing in Dollars rush to cover their shorts (buy Dollars).

Keep your eyes on the most-hated currency in the world. It could be flashing a signal that stocks are due to collapse.

Comments

[Roger Knights:]

"we may in fact be seeing the first signs of a rally in the US Dollar. If this happens, expect to see stocks and commodities (with perhaps the exception of Gold) completely collapse in a repeat of the second half of 2008. ... With so much of the investor world betting on a Dollar collapse, the stage is set for a major surprise here."

A surprise WOULD deliver maximum pain, so that's the way to bet.

Nov 02 11:55 AM

[cyclingscholar:]

The FED should take a page out of the Commie playbook and HINT that a rise in short term rates is 'just around the corner.' A huge selloff in commodities---oil, softs, natural gas, gold-- is exactly the kind of real kick the US economy needs to get going for real, instead of $250,000 a job stimulus street sweepers.

Nov 02 01:28 PM

[Dave Wrixon:]

Hairs on the palm of your hands is a good one.

Don't make the mistake of thinking that the Dollar will be regarded as a safe haven this time around. Might not be obvious to most Americans but the devaluation of the Dollar this year won't have been lost on foreign investors.

Nov 02 02:45 PM

[Carl Spackler:]

One thought keeps entering into my mind - if the dollar continues to fall, then Oil and othe commodities will continue to rise. Our economy started its big fall when Oil ran too high. According to many economists, the current increase in the price of Oil already has negated half the impact of the economic stimulus. If the dollar fell further and Oil went to 80, 90, or 100, wouldn't economic activity hit the skids? If this is true, the markets would fall, and the dollar would rally as everyone searched for a safe haven? It appears as though a dollar rally is really a "when" and not an "if" question. Long term, I am a big dollar bear, but the conditions do not support a big dollar fall right now. I hate to even consider buying the dollar, but it does look to be the smarter play right now.

Nov 02 06:05 PM

[yellowhoard:]

Carl,

The dollar is not the friendly rabbit or the harmless squirrel.

It is a varmint. The Fed has made it an adversary, like the Viet Cong.

The dollar is Varmint Cong.

And, as such, we're all licensed by the government of the United Nations to take all necessary actions.

So, we've got that going for us.

Which is nice.

Nov 02 06:19 PM

[untrusting ...:]

Good analysis and commentary. Would agree that some form of dollar rally is inevitable and if it forces some short covering which it probably will, it almost certainly will result in some downward corrections in stock and commodity prices.

Nov 02 10:33 PM

[Mark Anthony:]

Graham:

Your whole article is based on the premise that only less than 3% of the market is bullish on the dollar, the rest are all bearish so the dollar bear is a too crowded camp.

I don't know where you get this 3% number? Probably from the hear-says on the internet, with no solid data to back it up. If that number is wrong, then your whole article is wrong. Contrarian views do not always work. Many time it does not work. 99.999% of people will believe the sun will raise again tomorrow. I am not going to bet against that group. It's a historical fact that every fiat currency that has ever been experimented in human history has failed at the end. I am not going to bet on the dollar being an exception to that scientific fact either.

The 3% percentage is clearly wrong. China is the biggest foreign holder of US treasury bonds and US dollars. It wants to sell but could not. Do you count China as a dollar bull or a dollar bear? It's got to be a dollar bull, or why is it holding so much dollar?

And also look at the multi-trillion dollars held in US treasury bonds and in US bank savings account. All these people who still holds US dollar assets. Do you consider them dollar bull or dollar bear? I think you have to count them as dollar bulls. I am a dollar bear. I do not have a lot of cash in my bank savings account. I leave only enough in my bank account to pay my bills that's all. The rest of my money I invest in precious metals and related stocks.

How many people actually borrowed dollar to buy stocks and commodities? Maybe 1% or 2%. Almost none of the people I know use margin to buy stocks. So where is the dollar carry trade?

I think I am the minority, not the majority. Until at least 90% of all US banks fail because people withdraw their cash in a panic, I think the majority of sheeples are still dollar bulls, not dollar bears.

So your basic premise that the dollar bear being a too crowded camp is completely wrong.
seekingalpha.com/autho...

Nov 02 11:06 PM

[Carl Spackler:]

I like it! Funny!


On Nov 02 06:19 PM yellowhoard wrote:

> Carl,
>
> The dollar is not the friendly rabbit or the harmless squirrel.<br/>
>
> It is a varmint. The Fed has made it an adversary, like the Viet
> Cong.
>
> The dollar is Varmint Cong.
>
> And, as such, we're all licensed by the government of the United
> Nations to take all necessary actions.
>
> So, we've got that going for us.
>
> Which is nice.

Nov 02 11:32 PM

[SageNot:]

"The dollar is Varmint Cong.?" Are you under the impression that the US won the Viet Nam War, or are you trying out your Comedy Central gig here Carl?

Until the buck isn't the Reserve Currency of the world that it still is, all of the B.S. you guys shovel is exactly that, B.S.!

Nov 03 09:30 AM

[Carl Spackler:]

Hey Sage! Learn to read posts. I did not write the Varmit Cong comment, I was just commenting on it. FYI - it is a reference to the movie Caddyshack that another poster made because Carl Spackler is a character in the movie. BTW - cool your jets. While I am a LT dollar bear, I actually believe it is due for a good run up (perhaps overdue).

Nov 03 10:48 AM