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The Dollar Signal That Could Break The Bond Market (And Ignite Commodities) – What To Watch

|Includes:GDX, GLD, OIL, UDN, UGA, USO, PowerShares DB USD Bull ETF (UUP), XLE

The world currency devaluation scramble of central banks is still in full gear! Whether it be the Fed, the ECB, Bank of Japan, the People's Bank of China, or the Swiss National Bank, monetary authorities continually try to aim policy initiatives with a goal of devaluation without inflation. It is certainly a difficult goal, unless every government in the world has the same objective, which seems to be the case.

However, without explicit collusion of world leaders, world currency devaluation cannot be achieved in all countries. After all, one can only determine the value of a single currency by comparing it to another. In other words, even central banks with a desire to devalue a nation's currency may not be able to devalue it faster than another. Because of this, the nation's currency may actually become stronger. This article should provide some insight on the winners and losers of the world devaluation war.

One of the clear winners, thanks to Ben Bernanke's monetary policy, which is easy, easier than solving a colorless Rubix Cube, is the United States. Continuing its long term downtrend since 2000 it looks like the US Dollar is once again ready to take a further plunge in value. Yes, that would mean to expect higher prices; maybe not of most consumer goods, but definitely of energy, gold, and likely food.

Just as a quick side note, for gold bugs already getting excited about where this article is going, consider investing in gold denominated in Euros or Australian Dollars. Both currencies have been particularly strong and will likely continue their rises into the future. Therefore, investing in gold this way can achieve even greater returns via both gold and currency appreciation. The best way to do this, in my opinion, is to short a currency ETF, such as UUP, then invest that money into another currency ETF, such as the Euro ETF, FXE. Then, with other money, invest in a gold ETF of futures contract.

The pattern I have keenly watched for the last six months has been that of the US Dollar futures prices. During this time, it has been bouncing around a key support level around 78, while internal measures of momentum are deteriorating. The pattern is a head and shoulders top, one of the most statistically validated technical patterns in existence.

(click to enlarge)Click to enlarge

As you can see by the chart above, 78 is the support level that the dollar needs to hold above. If that level is broken, then the Fed's job of controlling inflation is about to get much more difficult. Continue to watch this level, and if it is broken, begin to prepare for an inflationary period. That means higher borrowing rates, lower bond prices, higher gold prices, higher energy prices, and higher stock prices (for a little while…). That also means that the "inflation sensitive" sectors will likely underperform, such as utilities, technology, and small caps.

Only about two percent away from spitting out a sell signal, the dollar may carry a key to the future of the US economy in 2013. With the large spike downward in the last week, and the continual punishment of US treasuries, I would expect the signal to occur shortly. Eyes open!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Stocks: UUP, GLD, USO, OIL, UGA, XLE, GDX, UDN