Yesterday we saw the DJIA go down 4.31%, the NASDAQ drop 5.08% and the S&P 500 lose 4.78%. Days don’t get much worse. Will the market bounce? Some people say no. Some think the bottom is at an S&P 500 value of 1175. Others say the bottom is at an S&P 500 value of 1195. Some think the bottom is far from where we are now. No one knows for sure. Last time we saw this kind of unabated fall, the S&P 500 fell from 1450 to 680. The Fed created bubble (via QE2, etc.) has eroded everyone’s confidence.
Is the European credit crisis another Black Swan event in which even gold and silver will fall? Today gold fell from a high of $1684.9/oz. to a low of $1642.2/oz (-$42+). It is currently at $1648.9/oz. Silver fell from a high of $42.295/oz. to a low of $38.47 (-$3.80+). It is currently at $38.90. In the Lehman mediated downturn of 2008, gold fell approximately 30% from its high. If this situation is a repeat due to the European credit crisis, gold could see a major fall again.
Even if gold holds up well, that could mean a fall of 10%. We have already seen other commodities such as oil fall that far and more. Do you want to chance a 10%+ fall? Or would you be one of the people who moves into cash? It is safer short term. Still if you’re like me, you prefer to take some positive action that you believe will earn you money.
One action you should consider is buying PowerShares DB USD Bull ETF (UUP). This investment seeks to track the price and yield performance of the Deutsche Bank Long US Dollar Futures Index. It tries to effectively be long the USD versus the Euro, the Yen, the British Pound, the Canadian Dollar, the Swedish Krona, and the Swiss Franc.
The US is still the world’s largest economy. The US Dollar is still considered by many to be a safe haven. It may lose out to gold in the longer term. However, in this short term panic, it may hold its value better even than gold. It may gain value versus other currencies as it usually does in a panic. When people want to raise cash, they do not sell USDs, they sell stocks, bonds, and gold. UUP does not tend to move on panic alone. Rather it should accurately reflect the fact that people will likely have more faith in the USD in these very troubled times than in most other currencies. Further the USD is in a relatively oversold state. The UUP should increase in value in the short term.
Why will the USD go up versus other currencies? First the Japanese government is now trying to manipulate the Yen downward. The Swiss government is doing the same for the Swiss Franc. Both the EU and the UK seem to be in worse straits than the US. Plus the US has recently ended the QE2 program that was pushing the USD downward. The USD is due for a rebound from this and the recently resolved debt ceiling fiasco. The ECB announced Thursday the reprise of the long term lending facility and other actions. Plus the ECB started its bond buying operations again to calm market turmoil. This is QE. It makes one believe there will be further easing activity by the ECB. Euribor futures show the financial markets have priced out further interest rate increases in 2011 by the ECB. In fact interest rate cuts are now considered more likely by many. This is the reverse of recent expectations for interest rate increases. The withdrawal of interest rate increase expectations in 2011 will likely push the Euro down, while pushing the USD up on a relative basis. The Euro is the most important market basket currency in the makeup of the UUP. A lower Euro will push UUP upward.
An alternative strategy would be to short the CurrencyShares Euro Trust ETF (FXE). This is an investment that seeks to track the price of the Euro versus the USD. Shorting FXE is equivalent to selling the Euro and buying USD. This will likely move further and faster than UUP. However, it is a less certain investment. With UUP you already know that the Swiss and the Japanese have taken direct actions to specifically devalue their currencies versus the USD. These are not likely a one time event. Both countries want to see their currencies move significantly lower versus the USD. Both countries are likely to take further actions to weaken their currencies versus the USD. These should provide further help for the USD to move upward. The ECB would like to see the same thing in order to make its exports more attractive.
In the ECB’s case there may actually be other overriding reasons for it to take quantitative easing actions. These actions might tend to support the weaker member countries' bonds, etc. Still the exact outcome and timing of those actions is less sure. You know the specific aim of the Japanese and the Swiss. With all three trying to move the USD lower, UUP's trend upwards is likely to be stronger and steadier.
The charts below show the recent movement in UUP and FXE.
The one year UUP chart is below:
click to enlarge
The UUP chart above indicates a near term bottom is being put in. The 200-day SMA is nearly flat. The fundamental reasons given above lead me to think UUP should start trending upwards soon. The recent triple bottom on the chart tends to support this theory from a technical standpoint.
One-year FXE chart:
The FXE's 200-day SMA is very close to rolling over in the above chart. The chart is already in a weak downtrend. The fundamental reasons given above make me think this downtrend will strengthen in the near term. This likely means one can make money by shorting the FXE.
If you hear that the US Fed is about to start more quantitative easing actions, you will want to reassess this trade. Thus far, there have been no such indications. In fact some argue that QE2 may have hurt the US economy. The Fed will likely be reluctant to restart further easing actions without significant evidence of deflation.
Actions by the US Congress that would inject further money into the system might tend to push the USD down too. You will have to assess the validity of this trade on each occurrence.