Change text size

• Email This Article
• Print This Article
• Digg This
• Delicious
• Subscribe

NOTE: Please look for the interview with Jay Kaeppel in the November 2009 issue of "Technical Analysis of Stocks and Commodities" magazine on newsstands now.

Let's start with a financial quiz:

• Did the U.S. dollar rise or fall in value today?
• Did the U.S. dollar rise or fall in value last month?
• Did the U.S. dollar rise or fall in value in the last six months?

I think it is a safe to say that the average person has no idea whether the U.S. Dollar (heretofore in most cases referred to as "the USD") was up or down in value today relative to other world currencies. Or in the last week, or in the last month, or even in the last year. Let's face it, we all have a lot on our plates these days - unless your own personal job was not "saved" or has yet to be "created," in which case you may a bit less on your plate at the moment. But in general, for most of us the action of the USD certainly falls under the category of "one of those things that I have no control over," and therefore many people feel compelled not to waste a lot of energy worrying about it. And in essence, they are the lucky ones. Because the people who do worry about it (not to be confused with the government officials who "should" worry about it) aren't even entirely sure whether they should be rooting for a strong USD or a weak USD. And in fact it is a little complicated.

STRONG DOLLAR VERSUS WEAK DOLLAR

There is one camp that backs a "strong dollar." In this camp a strong USD is considered to be a sign that all is right with the world (at least to the extent that all can be right with the world these days) and that the United States is held in high regard - at least financially speaking. In general a strong dollar suggests that investment capital will flow to our shores, which is a good thing.

Nevertheless, another camp favors a "weak dollar" (for the record, this camp has been throwing regular parties of late). Those in this camp primarily view a weak dollar as a way to make it easier to sell U.S. products overseas. In theory, a weak dollar makes our products cheaper in the global market, thus increasing demand, thus increasing jobs and international sales for U.S. companies (hey, I said it was a theory). One primary problem with a weak USD is that it makes foreign goods more expensive to import. Hence a weak dollar can ultimately lead to inflation

As a country's currency begins to fall too precipitously the Central Bank in that country typically will raise interest rates to make investments denominated in their particular currency more attractive.

Oh, and one other important thing to keep in mind. Historically a plunging currency can presage an economic collapse for the country in question, as it is a sign that investment capital is fleeing that particular country. So just remember that there is a limit to the benefits of a weaker dollar.

And of course, there are always those in the "third" camp who argue that there is a time to push for a strong USD and a time to push for a weak USD based on current market and economic conditions. Ironically, although in reality those in this camp are exactly right in believing that there is a time to "ebb" and a time to "flow," so far we haven't found anybody smart enough to correctly figure out what time is right for which. Sadly the people in this camp typically:

1) Often have not the slightest what they are talking about at any particular point in time.

2) Always push for us to "flow" when we should be "ebbing" and to "ebb" when we should be "flowing."

3) Are the very people who make the actual decisions regarding dollar policy. Republican, Democrat, no matter.

SO WHERE ARE WE NOW?

As I alluded to earlier, the folks at "Camp Weak USD" are having mixers just about every weekend these days. Figure 1 displays the spot U.S. Dollar versus a number of foreign currencies. Does anyone notice a trend?

Figure 1 - The U.S. Dollar versus (clockwise from the upper left) Australian dollar, British pound, Canadian dollar, South African Rand, Japanese yen and the Euro

Clearly the USD has been falling hard versus all manner of foreign currencies in 2009. In fact when the mighty U.S. dollar plunges 35% versus the South African Rand it is approaching time to wonder just what the heck is going on. Now whether all of this is being caused to happen on purpose via government policy or via market forces (er, wait, I'm pretty sure market forces have been outlawed - I'll have to double check) is as much of a political question as it is a financial one. I will leave that portion of the argument to the forehead-vein bulging pundits on both sides as they square off and passionately shout out their standard talking point on all those fair and balanced stations like, like, well, it will come to me eventually.

In any event and as always, as a yet unrepentant greedy capitalistic, my self serving concern is not with the politics involved but with the money-making - or in this case, potential money-losing - implications. And here is where it gets tricky. Which not surprisingly leads us directly to""

WHERE IT GETS TRICKY

In recent years an extremely wide swath of all investable markets and securities has fallen into an inverse relationship with the USD. In plain English, this means that when the USD rises, these other "things" decline in price, and when the USD declines, these other "things" rise in price.

For Figures 2 through 4 we will use the USD versus the Euro (EC) in the top clip as our "measure of the U.S. dollar". Figure 2 shows USD/EC versus the S&P 500 stock index. In 2008 the dollar advanced sharply and the S&P (and virtually all world stock markets) tanked. Around March 1st of 2009 the dollar began to fall steadily. The stock market has marched relentlessly higher since.

Figure 2 - USD (versus the Euro) versus the S&P 500

Figure 3 displays the USD/EC versus Gold futures. The same relationship applies here. Big gains by the USD are accompanied/followed by big declines in gold and declines in the USD are accompanied/followed by advances in the price of gold.

Figure 3 - USD (versus the Euro) versus Gold bullion

Figure 3 displays the USD/EC versus crude oil futures. When the USD started to rally in July of 2008, crude oil immediately began to tank. And since the USD topped out in March 2009 crude oil has roughly double in price.

Figure 4 - USD (versus the Euro) versus crude oil

The obvious thing to note in Figures 2 through 4 is that every time the U.S. Dollar rises in value (again, in this case versus the Euro), the "other" market in question typically falls in price, and when the U.S. Dollar declines in value, the "other" market typically rises in price. Table 1 below provides a handy guide to all of this that you can cut out and put in your wallet or purse.

Table 1 - U.S. Dollar versus Pretty Much Everything Else Handy Relationship Guide

This relationship has profound implications for investors of all stripes. 'Tis a pity that most investors have no idea that this is the case.

SO WHAT DOES IT ALL MEAN?

I don't claim to be an expert on foreign exchange rate stuff. In fact, currency conversions make my head hurt. Nevertheless, let me take a stab at summing up the potential implications of future movement for the USD.

1) If the dollar continues to decline, we should look for domestic and foreign stock indexes, crude oil, gold and most commodities to continue to rise in price"

2) "that is, at least right up until the point that the dollar finally declines "too far" and we plunge into an economic collapse"

3) "but barring that, if the Fed eventually raises interest rates (from the current level of roughly 0%) then that may shore up the USD and stem the decline of the USD relative to other currencies. But before you start chanting "U-S-A, U-S-A"."

4) "remember that if present relationships hold, such an advance in the value of the dollar would likely be accompanied by a sharp decline in domestic and foreign stock indexes, crude oil, gold and most commodities"

5) "unless of course the present inverse relationships change, in which case all bets are off.

Got that?

SUMMARY

As I said at the outset, most people don't know nor care what is happening in regard to the value of the USD, just so long as they still have a few left in their pocket and/or bank account. But as far as I can tell, they definitely should care. In fact it would appear that they should care a great deal. So consider this your warning to pay heed to:

Jay's Trading Maxim #372 (which definitively states that): If the U.S. dollar starts to advance in a meaningful way, your stock and commodity related holdings will almost certainly decline in value - unless, of course, the current inverse inter market relationships start to fade. In which case, see Jay's Trading Maxim #373.

Jay's Trading Maxim #373: If current inverse market relationships start to fade, disregard Jay's Trading Maxim #372.
Is this foreign exchange stuff fun or what?!

In any event, here it is in a nutshell:

• If you root for a "strong" USD, just note that if your wish comes true the value of your stock, gold and commodity based investments will almost certainly decline in value.
• If you root for a "weak" USD, just note that if the USD falls too far it may ultimately lead to massive inflation and/or trigger/signal an impending economic collapse that would make 2008 look like a party.
• If you root for a "steady" USD, then you must have faith that the government officials in charge have a steady hand, know exactly what they are doing and are impervious to political pressures from both sides (har, good one Jay).

But the bottom line is this: the movement of the U.S. dollar affects you. You have been warned.

Jay Kaeppel
Staff Writer and Author of "Seasonal Stock Market Trends"

Optionetics.com ~ Your Options Education Site

Questions for Jay? Please visit "Ask the Traders" through the discussion board on the Optionetics.com home page.

NOTES:

Jay's latest book, Seasonal Stock Market Trends:The Definitive Guide to Calendar-Based Stock Market Investing, was ranked among the Top 10 Investment Books for 2009 by the venerable "The Stock Trader's Almanac 2010." For more info please click here.

Please look for the interview with Jay Kaeppel in the November 2009 issue of Technical Analysis of Stocks and Commodities magazine.

• Email This Article
• Print This Article
• Digg This
• Delicious
• Subscribe

Recent Articles by Jay Kaeppel, Optionetics.com

• March 16, 2010
  Kaeppel's Corner: Catching Up on a Few Ideas
• March 9, 2010
  Kaeppel's Corner: And Up Through the Ground Came a Bubblin Crude...
• March 2, 2010
  Kaeppel's Corner: Forecasting the Stock Market in 5 Minutes a Month
• February 23, 2010
  Kaeppel's Corner: You Are What You Think You Are
• February 16, 2010
  Kaeppel's Corner: Dr. StrangeMarkets