A Relief Rally For The U.S. Dollar As 'Safe' Alternatives Get Expensive

Includes: FXF, FXY, GLD, UDN, UUP
by: Dr. Duru

It took a whole month before the dollar finally launched into the relief rally I thought would soon follow the S&P’s downgrade of U.S. government debt. Even after the Swiss franc’s rein as a “safety” currency ended a few days later – first with a threat and then the implementation of a currency peg – the dollar continued to drift lower.

A fresh run on the euro that has sent currency traders scurrying for the dollar instead of the franc has sent the dollar index soaring nearly straight up. In just eight days, the dollar index has gone from scratching at three-year lows to an important breakout.

[Click all images to enlarge]

The U.S. dollar index breaks out

The U.S. dollar index breaks out

As I have stated before, the 200-day moving average (DMA) has been an important line of support and resistance for the dollar index for year. During its steady descent from 2002 to the end of 2004, the 200DMA marked the downward trend. (The 200DMA is marked by the blue line in the chart below).

The dollar

The dollar's slide was persistent even as the U.S. came out of recession

In 2005, a break above the 200DMA confirmed a large relief rally from the lows at the beginning of that year. By early 2006, breaks below the 200DMA signaled the resumption of the long, secular downtrend.

The dollar

The dollar's secular downtrend resumes after breaking the 200DMA in early 2005

Finally, since 2008, breaks above and below the 200DMA have preceded large and sustained moves in one direction. Assuming the pattern repeats, the dollar’s latest relief rally should continue for several months if not longer.

The 200DMA has recently served as an important predictor of the dollar index

The 200DMA has recently served as an important predictor of the dollar index's near-term future performance

*All charts created using TeleChart

Currency traders may get more inclined to return to the dollar for “safety” because it is now “cheap” relative to the existing alternatives like U.S. government debt and the Japanese yen. The yield on the 10-year Treasury is now at a record low although further manipulation by the Federal Reserve could, I suppose, drive yields even lower. The yen hovers near record highs against the U.S. dollar. The Japanese monetary authorities have made it abundantly clear they think the yen remains too strong but so far they seem powerless, unable to print enough money to discourage buyers and satiate demand.

The Swiss have created a peg of 1.20 against the euro. If the euro continues to sell off, their resolve will surely get tested (or at least the gears and switches of the currency printing presses will get tested). Besides, traders seem to love to test the resolve of central bankers and related monetary authorities. I have positioned myself long the franc in order to play just such a test.

This leaves us with gold. So far, gold remains near its recent highs and has been unperturbed by the dollar’s renewed vigor. After all the dust settles, I expect gold to emerge from the constant manipulation and devaluation of currencies even stronger and higher than it is now.

Next stop, the Federal Reserve meeting September 20-21. This event represents the next threat to the dollar’s nascent rally.

Be careful out there!

Disclosure: I am long FXF, TBT, GLD, GG. I am also net long Swiss franc, net long U.S. dollar, short Japanese yen.