How Will A Surging Dollar Affect Your Investments?

| About: PowerShares DB (UUP)

There is a major shift in the currency markets underway… At its very core, it’s contrarian, and it’s surprising many conventional investors.

Despite everything you may have read about the Fed’s irresponsible debt purchases, despite the worries about inflation and “worthless” fiat currencies, despite what the “experts” believed would happen, the U.S. dollar is getting stronger.

The whole situation starts to make sense when you look at the granular details. While the Federal Reserve has kept interest rates at historically low levels for years, policy is changing and rate hikes are now on the horizon. Higher U.S. interest rates naturally help to strengthen the U.S. dollar, because international investors can buy dollars and receive a higher rate of return on their investment.

Different Story Overseas

Meanwhile, things in Europe are getting risky again. Periphery countries are mired in depression-like economic challenges, while Germany (one of the strongest European economies) is now officially entering a recession. This situation does not bode well for the value of the euro, as the European Central Bank (ECB) may eventually see its hand forced toward taking drastic measures.

Of course, we can’t talk about currencies without mentioning the challenges in China – and how that affects global markets. China’s real estate bubble is now in the process of deflating, and the country is backing off on infrastructure projects. This affects countries, such as Australia, that are natural suppliers of raw materials to China. If China isn’t buying copper and iron ore from Australia, that is bad news for the Australian dollar (and more fodder to help push the U.S. dollar higher in comparison to other key currencies).

Today, we’re seeing the dollar surge versus the yen, the Canadian dollar, the euro and the Australian dollar. It may fly in the face of the “conventional” assumption that the U.S. dollar is dead. But there is no denying the recent strength of the greenback.

What This Means for Your Investments

There are two key issues that investors need to be aware of when it comes to a rising dollar. The first has to do with interest rates and dividend stocks, and the second is related more to stocks with exposure to commodities.

We have mentioned several times before that a rise in interest rates will create challenges for traditional blue-chip dividend stocks. Investors who would prefer to have their capital in interest-bearing securities such as Treasury bonds or CDs have been forced to buy dividend stocks. This is because the yields on rate-sensitive income investments have just been way too low.

With interest rates already starting to tick higher, these investors now have the option of moving back out of dividend stocks and into CDs and other fixed-income securities. If you’re holding a conventional dividend play such as GE (NYSE:GE) or Coca Cola (NYSE:KO), you may want to consider lightening up on your position for the next several quarters.

The second area to keep an eye on is commodities. Remember, a stronger dollar means it takes fewer dollars to buy specific commodities. Looking at the picture from a different perspective, we can see that the price of these commodities will naturally fall.

We’re already seeing the price of oil decline (which in itself is worth discussing at length at another time), and I’m very curious to see how the surging dollar will affect precious metals such as silver and gold. There is an interesting divergence here because precious metals often see capital inflows during times of uncertainty. That certainly characterizes this time period, with so much economic AND geopolitical change in play.

But at the same time, gold and silver should come under pressure if the dollar continues to rise. This is simply because with a stronger dollar it should take fewer to buy an ounce of gold or silver.

Uncertainty Lingers…

Right now, it is unclear which side will win this battle. Will uncertainty cause traders to push up the prices of metals? Or will a surging dollar drive them lower? Only time will tell…

In the meantime, I’m keeping a close eye on the gold and silver miner stocks that have been in my income portfolio. Several of these stocks pay great dividend yields and have been in favor over the last few months. It’s not time to punt and bail out of these stocks yet, but I’m certainly keeping a close eye on the situation. If we see erosion in the price action for these names, I won’t hesitate to move out of the stocks and into cash (which may be a great position if the dollar gets stronger).

As we move out of the lazy days of summer and back into an active market environment, please stay vigilant with your investments. The biggest strength of any successful trader is the ability to manage risk – and today, there are plenty of risks to be managed.