August 07, 2010

Summer Blues For The Dollar?

The currency markets have officially entered summer vacation.  Volume is down and so is the Dollar pretty much across the board.  Having dropped more than 9% since the recent high of 88.50 in Mid-June, the US Dollar Index is now testing the 200-day moving average (see red line below).


By contrast, the Euro has been rising from the ashes for several weeks now, making a strong comeback. The single currency has now entered the technical retracement areas as depicted by the Fibonacci retracement levels in the chart below. 


More significant than the Euro strength, it is rather the overall US Dollar weakness making a continued rise in the Euro a likely outcome, not just a technical trading scenario.  The Dollar weakness has been even more apparent versus the Japanese Yen.  The greenback’s drop to 85 on Friday has been the lowest point since 1995, on the back of record low Japanese yields.  The last time 10-year Japanese Government Bond yields were below 1%, the US Dollar traded above 100 giving you an indication of just how much the sentiment has turned against the greenback in recent weeks.


Yet another way of looking at the Dollar woes is to plot the price of Gold in Euros rather than Dollars.  While there is no doubt that Gold has been a fantastic trade in the past decade, there is some concern about loading up on the most “precious” of all metals, when every small investor seems to be trying to jump on the band wagon.  I have raised these concerns in a previous article Kramer says: You must have at least 1/10 of your portfolio in Gold - I say: Not so fast! 

In Euro terms, the price of Gold has dropped over 13% since the all-time high in June.  Combine that with an average 7% premium over the spot price of Gold that an average investor has to pay for some of the physical and quasi physical gold investments out there and you’re looking at a drop of 20% for a Euro denominated small Gold investor – not something a small investor can stomach that well.


The US based investor may take some comfort in a small percentage allocation of Gold against a possible dilution in the value of the US Dollar.  However, one must keep in mind that Gold trades like a commodity and can be volatile. 

Going back to the US Dollar, the recent economic concerns expressed by Fed chairman Ben Bernanke combined with persistently stubborn levels of unemployment make a good case for another round of quantitative easing.  The prospect of US rates effectively dropping further will continue to put pressure on the US Dollar.  If the US were to follow the same economic fate as Japan did for the past two decades, then there is some hope for the US Dollar catching the curve again, despite ridiculously low yields.  Yet, it is questionable whether the US Dollar can retain its value against all other currencies while keeping rates at or near historic lows with record Bond prices but also enjoying a continued rise in the stock market. Something has got to give; take a pick as to which market will do the giving...

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