Monday, July 13, 2009

US Dollar - a bullish prognosis

The July G-8 Meeting and the US Dollar

Every once in a while, the right thing to do is to change your mind. One year ago was a good time to change your mind about buying and holding stock for the long term. And right now is a good time to stop being bearish on the US dollar.

The overall trend of the US dollar is the most important economic trend in the world right now. Last week the heads of state of the biggest economies in the world were huddling in Italy to formulate their next play in the world’s economic stadium. Since 2007, when the US sub-prime lending fiasco erupted, they have been aggressively cooperating to try to stabilize the world’s banking system. At this July’s G-8 meeting, they must have been feeling very proud of themselves for doing such a good job. By and large, most of the world’s banks have survived.

But, one surprising economic fact has remained hidden in all the reassuring rhetoric and political posturing: the long-term trend of the US dollar has reversed. It’s going up now.

Analysts measure the US dollar against a basket of foreign currencies made up of the euro, yen, British pound, Swiss franc, and several other minor currencies [including our Canadian dollar]. On this basis, the US dollar entered a long-term bear market in the winter of 2001-02, at a price of approximately 120. It traced out a six-year zig-zagged decline that ended in spring 2008 at about 70 – that’s an over 40% decline! That significant, long-term down trend happened during George Bush’s Republican administration. The US dollar’s downward trend ended with a world banking crisis and the bailout of America’s biggest bank, biggest insurance company, biggest brokerage firm[s], biggest mortgage company and biggest auto manufacturer.

And now an overwhelming majority of currency analysts hate the US dollar. They think it’s going lower. The financial press is full of reasons why the US dollar will resume its long-term down trend. But that’s not what’s happening. Last year it rallied 28%, from 70 to 90, followed by a 10% decline to its current level of just over 80. And now that US dollar is around 80, the economists all hate it.

This is the perfect set-up for the American dollar’s up trend to continue.

G-8 central bankers would like to see a stronger US dollar because it is the reserve currency of the world’s banking system. When a bank’s reserves depreciate, the banks become weaker. Will the world’s central bankers get their way? Will the US dollar continue its long-term up trend?

The answer to this question does not lie in the secret minutes of the backroom meetings that occurred at the G-8 conference last week. The answer is in the attitudes and actions of economists and analysts all over the world. If they continue to be bearish about the US dollar, they will continue to act negatively in the currency marketplace. They will continue to hedge their currencies to protect themselves from the weaker dollar they forecast. But if the US dollar continues to hold up under this hedging pressure as it has for the past few months, the up trend will re-appear. The central banks will get their way. And the second consecutive year of US dollar strength will emerge.

Ken Norquay, CMT
Chief Strategist, CastleMoore Inc

Links to my book, Beyond the Bull:



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