Declining Dollar: This Trend Is Not Your Friend

by: Moby Waller

The current market situation reminds me of some quotes by "wise men" of the past:

"It's all about the Benjamins baby" — Rapper P Diddy

"Follow the money" — Watergate's Deep Throat

"Go where the money is" — Bankrobber Willie Sutton

The bottom line currently is that the declining dollar seems to be more and more of the impetus pushing dollar-denominated assets such as U.S. stocks [using (NYSEARCA:SPY) ETF as a proxy], gold (NYSEARCA:GLD), and crude oil (NYSEARCA:USO).

Historically there is NOT a strong correlation between the movements of the dollar and these assets. However, since last June we've seen an inverse relationship between these widely traded securities. We're using the (NYSEARCA:UUP) ETF as representing the dollar, since all four of these ETFs are widely available for trading for virtually all investors.

You can see in the relative performance chart below that UUP is down over 17% since June 2010. And during this exact time, we've seen a relatively steady uptrend in SPY, GLD, and USO, which are up 22% to 35% in that same time frame.

This certainly looks to me as if the declining dollar tail is wagging the asset dog. Money held in dollars has flowed into stocks, gold, and oil as they become relatively "cheaper." And you don't want to fade this type of strong trend, as the many bears have found when their paws keep getting trapped on days like Wednesday with huge gains in the markets.

UUP, SPY, GLD, USO Relative Performance Chart

(Click to enlarge)

Long-term, as I've stated many times, a weak currency is NOT a good thing for an economy/country in my view. The U.S. economy has thrived many times in the past when we had a strong dollar. In fact, the risk of inflation rises grows as the dollar drops (and some may see this rally in stocks, gold and oil as a form of asset inflation).

A weak/declining currency is a sign of a country with a poor balance sheet — and while we're not at the point of no return/third world status yet, a collapsing currency is what has caused hyper-inflation (and even revolutions/regime changes) historically in countries around the world.

Take a look at the Federal Reserve's own long-term charts for the Major Currency Index and Broad Currency Index below (this and much other good data is available for free download at the Fed Reserve website).

You can see that the Major Currency Index in place since 1973 is on the verge of breaking to new all-time lows — although we haven't yet eclipsed the lows of a couple years ago during the financial crisis. Both of these dollar measures are clearly in sharp multi-year downtrends.

Federal Reserve Broad and Major Currency Chart

(Click to enlarge)

To see the loss of "wealth effect" for Americans, simply compare what traveling to continental Europe would cost now versus what it did 10 years ago (and to the historical ranges of the currency exchange rates). Remember that the euro (NYSEARCA:FXE) was originally designed to trade around 1.00 and it stayed within a 0.80 to 1.20 range for several years after it was created — it closed today at 1 euro = 1.45 dollar.

The Japanese yen (NYSEARCA:FXY) is similarly very strong historically versus the dollar currently. Other currencies such as the Australian dollar and Canadian dollar that have big made gains against the U.S. dollar can be somewhat explained by the relative importance of natural resources to their economies.

So these are more countries where an American feels much "poorer" than he/she would have in the past — some point to the possible short-term economic/earnings benefit that our exports will be cheaper from a weak currency, but the drawbacks far outweigh the benefits in my view (and history generally backs this up).

In sum, as we always say "the trend is your friend" when it comes to investing and trading. And the trend now is a declining dollar which seems to be helping push many assets such as gold, oil and even stocks higher — so "don't fade the trend" for now, but keep in mind, from a U.S. citizen's perspective, that long-term a weak currency is not a good thing for our standard of living and economy.

Disclosure: ETF TRADR premium clients have been holding gold and energy bullish option trades. I am long USO. Clients are long GLD and XLE option positions. I also hold a short-term crude oil binary options position.