I will start off by saying that over the last 2 years a declining dollar has been a key investment theme in my portfolio. Foreign stocks, gold and a number of other sectors were riffs on the theme, so to speak. However, I find myself quietly thinking that perhaps it is time for a rally in the much beleaguered and much verbally maligned dollar.
The Fed is certainly doing its best to drive the currency down (despite the occasional verbal commitment to a “strong dollar” coming out of the treasury. QE1, QE Lite, QE2 – it all points in the direction of currency debasement.
I agree with nearly all the arguments that say the dollar is going to go lower.
However, despite the Fed’s actions and despite all the problems in the US economy, the US is not alone - trouble lurks elsewhere, too. Europe, for example, has a multitude of problems. Yet, it has been very quiet on the Europe front as of late. Amongst other things, I think this has resulted in the Eurozone getting too much credit in the currency markets.
Additionally, the dollar has no friends. It’s almost impossible to find anyone who thinks the dollar has a chance of appreciating. The requiem for the dollar is being played as we speak. In my experience, when everyone is on one side of a trade, it doesn’t work; generally, conventional wisdom fails.
Here’s a short list of few things that could trigger a dollar rally:
Negative event in a Euro periphery country – Greece, Portugal, Spain or one of the Eastern European members. A too big to fail country like Spain would be particularly damaging.
Euro-wide banking problem – I believe Euro-banks are in worse condition than most people think. Anything that sheds light on the problems would be a positive for the dollar.
Geopolitics – any serious negative geopolitical event would cause a flight to the dollar.
QE2 doesn’t work – at some point in the game, it just might stop working. There is at least some probability that the strategy to drive the dollar down doesn’t work. It can happen, ask Japan.
I’m not changing my long-term stance on the dollar, nor am I repositioning major positions in my portfolio. However, sentiment is such that the worst case scenario is likely reflected in the dollar, and some currencies, like the Euro, are getting too much credit.
Right now everyone says the dollar is a loser’s bet. But could there be an event that makes the dollar and all its problems look relatively better? I think so.
Disclosure: Long a few UUP calls