Three Reasons Why the Dollar's Not Yet Done

by: Investment U November 27, 2008 | about stocks: UUP    

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by Louis Basenese

Recall, in late March, I predicted here the dollar was overdue for a rally. Ninety-six percent of you cursed me. The other 4% pocketed an easy 20% or so (more if you played the options market).

But after such a swift run - mind you similar moves in currencies typically take years, not months - is the dollar rally finally coming unhinged?

Legendary investor Jim Rogers seems to think so. As he told Bloomberg News in a TV interview, he plans to exit his dollar holdings because he thinks the dollar “will go down a lot” and it is “going to lose its status as the world’s reserve currency.”

To which I simply respond, “Into what Jimbo?” No other choice for a reserve currency exists. No matter how much other governments wish it were so. The euro is frequently mentioned. But it’s depreciating in value. And there’s not enough liquidity to handle the demand. Plus, it’s still a prepubescent, experimental currency, not one governments can invest in with 100% faith.

Moreover, with two-thirds of foreign reserves already in dollars, it would take more than eight years to replace the dollar as the currency of choice.

So once again, I’m striking out on my own. (And I’m ready for the flood of fan e-mails.) While many pundits would like you to believe that the dollar rally will be short-lived, I completely disagree.

The dollar’s not done.

Today I offer up three more reasons why. And of course, three ways to play it.

Too Far, Too Fast? Hardly…

Keep in mind, currency rallies tend to be measured in years and months. Not weeks and days. In fact, according to Bespoke Investment Group, the average dollar rally lasts 489 calendar days. The longest rally on record lasted roughly 10 years.

While I don’t think we’re in store for a historic run this time, I do think the current rally has more legs (about another year based on the averages out of Bespoke).

Aside from no alternative world reserve currency, here are three more fundamentals in defense of the dollar:

Further Interest Rate Cuts
Foreign governments bought into the farce that was decoupling. As a result, they remained hawkish for way too long, keeping interest rates too high, at a time when they should have been cutting them to stimulate growth. And now they’re scrambling to catch up. They must make growth their first priority. So further interest rates cuts are inevitable, narrowing the gap with U.S. interest rates. And before long, perhaps the middle of 2009, we could be raising rates while other countries are still lowering.

Continued Deleveraging
As Mark Astley, CEO of Millennium Global Investments, a U.K.-based currency manager, notes, “there is a pyramid of leverage” in the financial markets that will take considerable time to unwind. The half-frozen credit markets are only slowing down the process. As they thaw out completely, expect hedge funds and foreign banks to keep buying up dollars.

Uncertainty Reigns
Despite a new president, uncertainty remains in the markets. Or as UniCredit wrote in a recent research note, “We do not expect global recession fears to wane considerably.” And during times of fear and risk aversion, the dollar tends to outperform.

Bottom line, the current rally has plenty of room to run. If you dare to be contrarian, here’s how I recommend you play it.

Consider Pure Plays
For a pure play on the U.S. dollar - without trading the currency markets - I recommend the PowerShares DB US Dollar Bullish Fund (UUP). It’s designed to replicate the performance of being long the greenback against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.

Another strong choice is the EverBank* DollarBull CD. Available in 3-, 6-, 9- and 12-month terms, it offers potential appreciation in the U.S. dollar against a selected foreign currency. If you opt for the latter, I recommend going long the U.S. dollar versus the euro.

Take Profits on Unhedged Multinationals
Consider taking profits in multinationals with significant foreign currency exposure. I say that because the rapidly strengthening dollar will dent future earnings in two major ways. First, because profits earned abroad will be worth less, as they’re translated back into dollars. Second, because demand for the company’s products will drop off, as they will be more expensive to foreign buyers. We’re already seeing this double-whammy hurt third-quarter results for some big multinationals. But if the dollar holds its ground, or strengthens further, the impact will be much more dramatic in the fourth quarter. So get out while you’re ahead.

Buy American
While the dollar was plummeting, it made sense to buy companies with significant international sales. They provided a nice currency hedge. However, a strong dollar means we need to reverse course and seek out companies with zero (or minimal) international revenues. I’d stick to solid companies in the utility, health care and consumer staples industries, as demand will remain steady no matter how long the recession lasts.

In the end, I know my dollar stance is contrarian. Or as many of you put it last time, “ignorant” and “completely out of touch.”

I’d add “profitable” to that list now. And I don’t expect this time to be any different.

*Disclaimer: The publisher of Investment U maintains a marketing relationship with EverBank, but it’s important to note that we’d recommend their products and services anyway.

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This article has 27 comments:

  •  
    Nov 27 07:22 AM
    Yes I agree with you. The dollar is correcting down as oil and gold go up short term.
    Reply | Link to Comment
  •  
    Nov 27 07:34 AM
    The most efficient economic system would contain a single currency. It will happen soon whether we agree to it or not, because in the next generation, everyone will have access to and know how to use the internet.

    If a government tries to print money, it will become immediately apparent to the world, and the index will adjust accordingly. It will be digital only, and based on a crunching of as many transaction prices as can be entered. Already grocery stores around the world track sales of chewing gum with scanned bar codes.

    All creditors will demand to be repaid under the adjusted global index. National currencies are obsolete.
    Reply | Link to Comment
  •  
    Nov 27 07:41 AM
    The US supposedly publishes the money supply, and the Fed's slosh report is public. If they try a stealth print, eventually it will get noticed and long-term creditworthiness will suffer. No one I knew really thought the Euro would last this long, but it represents economic gain in the form of lower transaction costs and greater predictability (despite recent increased intervention).
    Reply | Link to Comment
  •  
    Nov 27 08:18 AM
    Right On! Commodity prices will continue to fall in a deflatioary world and a strong dollar. I look to the Baltic Dry Shiping Index for conformation,(a new low today). When the index turns up, I will reavalvate my dollar position.
    Reply | Link to Comment
  •  
    Nov 27 08:26 AM
    Another reason the euro will not be the currency of choice has to do with demographics. The population is aging and this will lead to less economic value for the euro.

    If I understand this correctly, we are in a financial crisis of cosmological proportions. The Fed is injecting liquidity, and I applaud them for their 'soft landing' approach. However, the debt money will disappear, or is disappearing, faster than the Fed can replace it.

    We might just find ourselves at a level of money supply equivalent to Fed power money and far, far below (on the order of 70% or more) of our current money in existence. Add to that, the reduced global liquidity (about 10%) generated by the yen carry trade, and one can see global liquidity is in real trouble.

    So, if we enter a depression, the dollars remaining in existence will be highly valued, and the cycle of debt money will begin anew. That is, if we remain on the fractional banking system...which we probably will do.

    However, the dollar will certainly suffer in the process of recovering. "No nation has ever devalued its way into prosperity."

    All fiat currencies fail, and all currencies are fiat. Everyone is inflating their currency and we, the middle class, are losing our wealth. I pray we will establish a currency based on value, not debt, as a result of this crisis. Ah, but I dare not dream to see it in my life time.
    Reply | Link to Comment
  •  
    Nov 27 08:35 AM
    Furthermore, the author is correct. We will see inflation and we'll probably eat it for a while before interest rates hike. The US has been acting decisively and earlier (despite arguments the Fed is behind the curve) than the EuroZone. We will recover and fight inflation first.

    The only unknown is when the ECB will hike rates. They are charged with price stability, not growth, so their timing will be crucial.

    Think uncertainty is bad now, wait until the holidays. With half frozen credit markets and maxed our credit card debt, does anyone expect a merry Christmas for consumerism? Risk aversion will likely be on the rise by January. inflationary fears, or worse, will persist well into 2009.
    Reply | Link to Comment
  •  
    Nov 27 08:58 AM
    The author doesn't even mention the fact that the printing presses are running 24/7 to accomodate the out of hand deficit spending and the unconscionable bailouts.

    With trillions of dollars of debt with accruing annual interest in the hundreds of billions, what monetary or economic theory supports your claim? Sounds like hoping and wishing.
    Reply | Link to Comment
  •  
    Nov 27 09:18 AM
    During this $US dollar rally we have seen the dollar appreciate against most major currencies except one! The Yen has risen against the dollar and will continue to do so until the deleveraging business, the Yen carry trade unwind, comes to and end. This deflationary event has given the curtain for central banks to print massive amounts of fiat money and then inject it into the fanancial system. This reliquification will take time to work so I agree with the author's time frames for a stronger dollar to continue. At some point a reversal will occur in this trend and a tsunami of liquidity will raise real asset classes and give a false sense of boom followed by hyperinflation and eventual collapse of the dollar hegemeny.
    Reply | Link to Comment
  •  
    Nov 27 09:50 AM
    It is pure silliness to think that we will be raising interest rates soon. The dollars continued decline will resume just as soon as the hedge funds are through unwinding and tax loss selling is over. Euro countries will not continue to reduce rates the way the US has and the Euro will start to rise against the dollar as the US is relegated to a lesser position in the global comunity.
    Reply | Link to Comment
  •  
    Nov 27 10:01 AM
    Louis- As of the end of June 2008, official figures, compiled by the U.S. Comptroller of the Currency, showed a total derivatives exposure of the three largest U.S. bank holding companies—JP Morgan Chase, Citicorp and Bank of America—stood at more than $179 trillion. And the Bank for International Settlements put the amount of documented outstanding derivatives contracts worldwide at the end of 2007 at $675 trillion—still a fraction of the actual exposure.

    The margin calls are coming in and their is not $675 trillion to be found anywhere in the world! $800 billion is like pissing in a tin cup.

    The Dollar is not worth Jack S**t. We will be moving to a hyperinflationary era that will make the pre-Nazi economy look like good times. Do you not get it...that the entire fiat - debt monetary system is out of control and crashing.

    It is yet to be determined what if any RESERVE currency will exist within the next year. So take any profits you have and pack them into a wheelbarrow.
    Reply | Link to Comment
  •  
    Nov 27 10:26 AM
    The title of the article promises 3 succinct reasons for us dollar strength yet nothing is enumerated and you have 7 sections with identical bolded headings throughout the article.

    Rather than being able to skim your article quickly to see if it is worth being read, I actually have to read the damn thing. And then upon reading it I discover that you have actually given 4 reasons for the dollar rally to continue, all of them tenuous at best.

    1) USD is the world reserve currency with no alternative.
    There is always an alternative and that alternative is getting better and better all the time: a mixed basket of precious metals and non-usd currencies. Since when is 1 big almighty king-of-the-world currency critical to the functioning of our global economy? The most true statement ever spoken is this: "this too shall pass".

    2) Interest Rate Cuts
    You're right, other countries are more hawkish on interest rates. Their central banks have a different mandate than the federal reserve placing a higher importance on price stability. Foreign central banks will be the first to raise rates for the same reason that they were the last to lower them: they are more hawkish on inflation.

    3) Deleveraging
    When deleveraging finally ends, the reason to buy USD ends as well.

    4) Uncertainty
    Yes, uncertainty does currently reign and you are right that the dollar 'tends to outperform'. But past performance is not necessarily an indicator of future performance. In the past, the US was not the largest debtor nation in the world. In the past, the US had a strong manufacturing base and productive companies in efficient, competitive markets unimpeded by government intervention. In the past, Americans actually had savings.

    Good luck to all. Tell the truth.
    Reply | Link to Comment
  •  
    Nov 27 11:12 AM
    To read this article is to think that it is somehow normal for the $1.28 v. 1 Euro to show that the dollar contunues as a reserve currency. If anything, it is the Yen that is the new reserve currency. If the US were all that strong, the Euro and the dollar should be at parity as they were in early 2002. That was the best of times...no need for a converter. Everything priced right. What was wrong with that? Why can't Americans sell Made in USA products in Europe at parity? They had better learn how because when this is over it is going to be a new more competitive, manufacturing based global economy and I don't mean making things in China.
    Reply | Link to Comment
  •  
    Nov 27 12:14 PM
    Xsudden, yes, what theory describes printing money and avoiding inflation? None. But, all currencies are undergoing liquidity injections, so it's a relative thing, I suspect anyway. Furthermore, as long as the credit markets remain log jammed the creation of new money just isn't growing as fast as the Fed would like.

    I've asserted, global liquidity is in a downward spiral as investment dries up in the MBSs (derivatives) and the unwinding of the yen carry. These two phenomenon account for the lion's share (80% or so) of liquidity globally.

    Of course, the MBSs account for only a fraction of global derivative liquidity. So, for now, the liquidity decrease is not as great as it could be. When P/E values of home mortgages fell, that money left the system in the form of write downs and devalued assets. Now, if recession brings further P/E devaluing, maybe GM and GE, some more money will exit the system.

    So, the dollar should gain strength despite Fed easing. At least, that's my take. And, my take does involve some wishing, hoping, and praying we retain some of our dollar based wealth.

    We will see volatility in the markets, for sure. And any down turn in the dollar index could signal for some the impending doom of the dollar. But, one really needs to know what's going on behind the scenes. Many expect commodity prices to rise, and they just might. They may also be volatile and fall just as easily.

    Silverwood seems to be on track, in my view. He understands the liquidity affect generated by the yen carry, which as he states is winding down.

    JE has a good point. Hedge funds will pay off for a while, but will come to an end at some point. And the ECB is tasked with price stability, not growth (and price stability) as is the Fed's (dual) mandate. So, the EU may raise rates at the first sign of inflation and before the US Fed. Timing is everything.

    Mark, thank you. Yep, we've dug a huge hole for ourselves. I hadn't heard figures that high, but it's not hard to believe. Reserve currency,or not, we may soon find ourselves with a money supply worth the value of Fed power money: roughly 8% of total global liquidity. Interesting times, fellas.

    "In the past, the US was not the largest debtor nation in the world. In the past, the US had a strong manufacturing base and productive companies in efficient, competitive markets unimpeded by government intervention. In the past, Americans actually had savings."

    D, this is exactly what we need to get back to: real GDP and savings. I hope against hope, I guess. But, if the dollar fails, we had better devise a new banking system and currency, possibly pegged to some commodity prices. "If we (re) build it, they will come."

    I dunno, folks, a lot of variables and opinions. To tell the truth, we're all just in wait-and-see mode. Personally, I am hopeful we'll develop an representative currency and abolish the Fed and our current banking system. Fiat currencies just have a nasty tendency to fail. The dollar, the euro, the pound...maybe they all will fail together.

    In an admittedly sick sort of way, I am hoping for depression. We need to reboot our economy, our currency, and our banking system. We need to rethink this post industrial "experiment" and get back to real science and production. We need jobs and a currency based on value, not debt servitude to the rich. Dare I dream of better times ahead...after the crash, I mean?

    "Give me a (strong) dollar, or give me death." (Gotta be careful what we wish for, eh? LOL )
    Reply | Link to Comment
  •  
    Nov 27 12:30 PM
    I think the Japanese Cen Bank will intervene if the yen gets much stronger, they usually do. The USD, I read many places is a parking place for hedgefund stock sales liquidations until next year when they figure out
    what to do. Nov 15 was last day for investors in hedgies to request their monies by year end. The market almost always has risen before T-Giving,
    whether manipulated or what, up 1200 Dow pts parabolic is skeptical at best. I think USD run is finished for now, the XME is already indicating
    early investment in the inflation trade again, no? I see the USD pullback to the 20-day
    mov average.
    Reply | Link to Comment
  •  
    Nov 27 12:37 PM
    Sorry, shoulda checked my chart first! Dollar ALREADY BROKE 20-day, it's done rallying, and now headed to the Oct low 83 area/50-day moving average. CHART>
    tinyurl.com/6ej2bj

    The author may be right LONG term, but the USD is finished rallying short term. Besides, politics says it hurts exports.

    technically, MACD also is bearish. XME is place to be if chart is right.
    Reply | Link to Comment
  •  
    Nov 27 12:46 PM
    The strengthening of the $ may have started half a year ago, when the market was still up. I understand redemptions and margin calls in certain funds were the reason to sell assets that were bought on borrowed money and raise cash, and settle the deals with the investors to be payed in $. Now that the market has fallen to a level not seen in years, what exactly is the motivation to continue the deleveraging process? Selling typically subsides when the market bottoms out and I guess we are closer to the bottom than not.

    There are also possible deadlines like the end of the business year (say Oct 31) or the calendar year that have an impact on deleveraging.

    What drives deleveraging now that the conditions have changed?

    I suspect the relative strength of the $ is on borrowed time.
    Reply | Link to Comment
  •  
    Nov 27 12:58 PM
    Gordon, thanks for the update. You may be right. I am still waiting for risk aversion to kick in after a presumably grim Christmas shopping season. What say you?
    Reply | Link to Comment
  •  
    Nov 27 01:00 PM
    Great outlook Louis!

    I have been telling folks about McCain 3R Economic Energy plan and my company, Mealer Companies since the primaries. This can be proven via web search. Soon... Hopefully prior to Obama being sworn in and then removed as a Kenyan born, vs hawaiian born... Mealer Companies will unveal the Mealer AMC line of vehicles, our diversified and 100% USA based jobs and job building plans.

    We will rally the market. I will also diversify and invent my company and go public where we will branch out and create an umbrella of smaller LLCs and Corps that can also be invested in while growing this economy.

    Rather than rambling about my goals, I applaud your outlook and representation of the facts as they existed rather than how MSNBC, ABC, NBC or CNN would portray them.

    We will win in this "troubled economy" and we will win big. Let's just use our windfalls to start new small businesses and provide more USA mfg and USA jobs. China and China's investors can go by the wayside for all I care... And for all America knows about the greed... We can all watch the child and communistic slave labor trade end.

    Ignore my typos.. I'm not proof reading.
    Reply | Link to Comment
  •  
    Nov 27 02:20 PM
    WOW

    Someone talking my language. Check this out.

    www.youtube.com/watch?...
    Reply | Link to Comment
  •  
    Nov 27 04:09 PM
    In the Roadrunner cartoons, Wily Coyote chases the Roadrunner off the cliff. He hovers in space for a few seconds then looks down and drops like a rock. I think USD is like Wily: he has run off the cliff and is just about to give the audience that "Oh Sh*t!" look before gravity takes over. It always does.
    Things are only valuable relative to their scarcity, and USD has become much, much less scarce recently.
    Reply | Link to Comment
  •  
    Nov 27 05:02 PM
    go to zeitgeistmovie.com there are two movies watch the addendum one on the money system about the above mentioned banks


    On Nov 27 10:01 AM Mark Eibner wrote:

    > Louis- As of the end of June 2008, official figures, compiled by
    > the U.S. Comptroller of the Currency, showed a total derivatives
    > exposure of the three largest U.S. bank holding companies—JP Morgan
    > Chase, Citicorp and Bank of America—stood at more than $179 trillion.
    > And the Bank for International Settlements put the amount of documented
    > outstanding derivatives contracts worldwide at the end of 2007 at
    > $675 trillion—still a fraction of the actual exposure.
    >
    > The margin calls are coming in and their is not $675 trillion to
    > be found anywhere in the world! $800 billion is like pissing in a
    > tin cup.
    >
    > The Dollar is not worth Jack S**t. We will be moving to a hyperinflationary
    > era that will make the pre-Nazi economy look like good times. Do
    > you not get it...that the entire fiat - debt monetary system is out
    > of control and crashing.
    >
    > It is yet to be determined what if any RESERVE currency will exist
    > within the next year. So take any profits you have and pack them
    > into a wheelbarrow.
    Reply | Link to Comment
  •  
    Nov 27 06:17 PM
    Asby-- that retail analyst, the loudmouth guy who tells it like it is,& BEEN RIGHT too, said (Bloomberg tv) retailers are only surviving thru holidays, many will go BK in January.
    re: USD, David Fry has support at 81, that's below the 50-day (83ish) fyi
    scroll near bottom> www.etfdigest.com/dave...
    Reply | Link to Comment
  •  
    Nov 27 10:58 PM
    No lambasting from me. I think you've hit it. I have another reason though. I times of economic down turns I would bet against the ECB, and the BOE every time. They haven't disappointed once in the last 20 years. GA
    Reply | Link to Comment
  •  
    Nov 28 03:57 AM
    Dollar down through December, Up again in 2009. How much who knows, my guesstimate would be the 92 area.

    I look for Goldman to receive a Bailout package similar to that of Citi, they are hiding a lot of very toxic waste on Tier 3.

    The "flight to safety" will end sometime next year. Will the dollar continue to rise, I doubt it.

    Oil will rise with an increase in economic activity worldwide. I can't see the Dollar rising at the same time.

    IMHO
    Reply | Link to Comment
  •  
    Nov 28 06:19 PM
    Paul, you mean we might agree on something? :) I see the same thing,probably due to poor consumer performance. Now, how long that rally lasts is anyone's guess. I suspect we're in for a very prolonged recession, so risk aversion might be in play long term.

    Afterwards, though, it'll be a matter of timing. I suspect the Fed will fight inflation as agressively as they induced it to infate our way out of the (threat of) a deflationary spiral.

    As everyone knows, interest rates ar not their only tool. Bernie has been very agressive and innovative. He might just raise the reserve requirement to double digits in very short order, to 50%? He may reduce the money multiplier to very low levels, say 2 to 1. He may even call in all those acronyms (loans and swaps) to dry up excess dollars. And all this is probably planned and coordinated with other major central banks.

    In short, ease like crazy, then tighten like mad. He'll swerve to prevent hitting the proverbial pole in the road. If so, this speaks well for long term dollar strength and US consumer wealth. I haven't really analyzed such an affect abroad.

    Gordon, again, thank you for some insight. I'll need time to absorb your data.But, off to work now.
    Reply | Link to Comment
  •  
    Nov 29 09:48 AM
    No way the money that becomes more paper than of value is because print money is still nothing but paper money no matter what kind of game you are playing. Earned money is capital money and appreciating money is to produce and to sell what you have produced. We need an economics.
    Reply | Link to Comment
  •  
    Nov 29 09:02 PM
    OK with the $ analysis but if you want to buy smthing from Everbk, check it out well; you have the risk, they keep the margin.
    Reply | Link to Comment
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