Stock Market Crash! Blog

The Dollar Declined.....What Comes Next?

The US Dollar has plummeted by 8.6 percent since December 2005 on concerns running the gamut from the end of Fed rate tightening, Iran-related worries, alarming growth of the twin US deficits and rising interest rates overseas, especially Japan. As a consequence, the Euro has risen 11.1%, the British Pound 10.4%, and the Japanese Yen 11.5%.

The Dollar's decline to near 10-year lows has raised the ire of Asian exporters, like Sony, Canon, Toyota and Samsung, who's overseas earnings erode as their home currency strengthens, while helping to precipitate a panic on the Asian bourses, with Japan's Nikkei taking a 1,500 point, or 8.5%, haircut. Similarly, the Korean market lost 6.8%, Taiwan 6.6% and Singapore 6.4%, all within a week. So far, Japan has only made attempts at verbal intervention, not yet resorting to cashing in their Yen for the greenback.

The escalation of the Iran crisis since January 2006 has caused investors to shun the US Dollar in favor of the traditional safe-havens, gold and silver, helping them to rise an bubble-esque 35% and 55%, respectively. Copper has almost doubled, having risen an unsustainable90% since January. We'll go into more depth about the commodity boom and its implications in the next post.

I'm of the opinion that the Dollar is due for a rebound very soon, and I have some pieces of evidence backing my claims. Of course, I could end up completely mistaken, but thats why I trade with stop losses. There are times when my forecasts end up being mistaken, I take a small loss, and sometimes even reverse my position ending in a profitable trade. Its critical to be nimble and flexible in your trading, admitting that you were wrong and not marrying a particular position or market viewpoint. Pride ≠ Profit !!!

Here is why the Dollar is likely to rise:

1) Widespread Pessimism: The public's sentiment for the greenback is overwhelmingly bearish at the moment, as everyone ranging from news reporters to finance ministers to retail salespeople are convinced that "the dollar's going to crash." This widespread pessimism perks up my contrarian ears, knowing that "the crowd is always wrong."

In markets, whenever a majority of participants carry a strong belief about a market's direction, the opposite tends to happen. The reason for this comes from simple logic: if everyone is bearish, and has presumably taken bearish positions in the market, who else is left to keep up the selling that is necessary for the decline to continue? Thrown into the mix is the fact that the crowd has strong inclination to overreact after long trends, and you have fertile ground for a rally. In short order, some participants buy back their positions, eventually culminating in an avalanch of short covering as the market rebounds in the most vigorous manner. At this point, traders on the sidelines start to pile on long positions looking for more gains on the upside, until the whole process repeats itself! Obviously, doing the opposite of the crowd is very profitable.

Here are just some of the many recent editorials showcasing such extreme pessimism:

Dollar May Extend Decline to Longest Since August, Survey Says

The Dollar is set for a large decline, here's why

A New Phase in the Dollar's Decline

ETFs For The Dollar's Decline

Free Special Report: "Currency Crash"

2) Asian central banks are likely to intervene by selling their currencies and buying dollars in an attempt to stem the Dollar's decline and preserve their countries' business climate.

3) There appears to be a bullish head & shoulders bottom chart pattern being formed:



The head & shoulders bottom provides a minimum price target to be reached upon the pattern's completion. You can find this target by measuring the vertical distance at the widest point in the pattern, from the low of the "head" to the "neckline resistance level" and then adding this measurement to the value at the neckline. In this case, the vertical distance is 12 and the neckline is 92, giving a minimum price target of 104. At this level, the Dollar may level off before resuming its previous uptrend. If the Dollar falls much below the right shoulder at 83, however, I would disregard this pattern.

You can continue to track the progression of this pattern at here at Stockcharts.com.

4) The Creation of ETF's To Hedge Against The Dollar's Decline: Financial companies have created investment instruments for the retail investor to take advantage of their bearish forecasts for the Dollar. This is bullish, in the same vein of the contrarian philosophy discussed before. Don't get me wrong, its about time these instruments were created- they're brilliant, but the fact is that they came about late into the game, a strong indication the trend is over.

According to an International Herald Tribune article:

"The Franklin Templeton Hard Currency is the largest in the field, with $214 million in assets. It essentially bets against the dollar, with holdings in short-term, foreign-denominated, fixed-income securities from a variety of countries. It is designed to rise sharply when the dollar takes a big fall."

"A fund with a similar strategy, the Merk Hard Currency fund, began trading last May and has garnered about $11 million in assets. It has returned 2.1 percent this year."

"Other currency mutual funds introduced last year by ProFunds and Rydex follow the riskier strategy of using leverage to magnify their returns. The ProFunds Falling Dollar fund and the Rydex Weakening Dollar fund both use derivatives so that they will rise twice as much as the dollar falls."

There is "yet another alternative for investing in foreign currencies that was introduced last year: the Euro Currency Trust, an exchange-traded fund that began trading on the New York Stock Exchange in December."

According to The Street.Com's Roger Nusbaum: "There are two gold exchange-traded funds in the U.S., with a silver ETF and a crude oil ETF on the way. I expect a copper ETF will be created soon as well." Commodities, especially precious metals, have a inverse relationship with the Dollar and represent ways of profiting from a falling Dollar.

5) The smart money is buying the Dollar, while selling the Yen, Euro and Pound: This information was gleaned from the Commitment of Traders weekly futures reports that show the futures market position sizes of three different trading groups, the small traders, large traders and commercial traders.

The commercial traders are large banks and other "insiders" or "smart money" who have an extremely strong track record of predicting market turning points. When the commercials take on large long futures positions, the market tends to rally not much long after. When they take large short positions, the market tends to fall, often violently. The charts have red dots corresponding with commercial sell signals, and green dots corresponding with commercial buy signals.

Consequently, the large and small traders end up on the wrong side of the market at turning points, tending to trade in an opposite fashion to the commercials. Whenever these two take an extreme position, do the opposite!

The following charts show commercial positions in blue, small traders in red and large traders in green. Please visit Timingcharts.com to see other charts like this.

Here is the US Dollar Index. Commercials are taking a very large bullish position, while large and small traders are heavily short. Click on the chart for a larger version:



Here is the Japanese Yen, which trades inversely with the Dollar. Commercials are heavily short, while large and small traders expect much more upside. Click on the chart for a larger version:



Here is the British Pound, which trades inversely with the Dollar. Commercials are heavily short, while large and small traders expect much more upside. Click on the chart for a larger version:



Here is the Euro, which trades inversely with the Dollar. Commercials are heavily short, while large and small traders expect much more upside. Interestingly, commercials are short a staggering 100,000 contracts, making for the most bearish commercial position ever held in the Euro. These people know something. Click on the chart for a larger version:



How can you take advantage of a rising Dollar?

One is to actually buy the Dollar with a forex account which can be opened at FXCM, where they allow you to leverage your position up to 100x you initial investment. This leverage can create fantastic gains or losses, so use a stop-loss, and only trade with a small percentage of your account value.

Another technique is to short sell futures contracts on Yen, Pound or Euro, also an inherently leveraged position.

There are even some mutual funds that track the Dollar, while incorporating some leverage. The ProFunds Rising Dollar (symbol RDPIX) and Rydex Strengthening Dollar (symbol RYSDX) funds aim to rise twice as much as the dollar when it is rising.

A rising Dollar is also bearish for precious metals and precious metal stocks, so taking profit in these assets is a smart move.

I'll keep posting on any further developments.