An Inconvenient Truth About the Dollar

04/22/2011 7:00 am EST

Focus: FOREX

Moby Waller

Editor, Wyatt Research

While the declining dollar seems to be fueling gains in stocks and commodities like gold and oil, the fact remains that a weak currency is a major long-term concern for the health of the US economy.

The current market situation reminds me of some quotes by “wise men” of the past:

“It’s all about the Benjamins baby” – Rapper P. Diddy
“Follow the money” – Watergate’s Deep Throat
“Go where the money is” – Bank robber Willie Sutton

The bottom line currently is that the declining dollar seems to be more and more of the impetus pushing dollar-denominated assets such as US stocks (using the Spyder Trust (SPY) as a proxy), gold (SPDR Gold Trust (GLD)), and crude oil (United States Oil Fund (USO)).

Historically, there is not a strong correlation between the movements of the dollar and these assets. However, since last June, we’ve seen an inverse relationship between these widely traded securities.

We’re using Powershares DB US Dollar Index Bullish Fund (UUP) to represent the dollar, since all 4 of the above ETFs are widely available for virtually all investors.

You can see in the relative performance chart below that UUP (red line) is down over 17% since June 2010.  And during this exact time, we’ve seen a relatively steady uptrend in SPY, GLD, and USO, which are all up 22%-35% in that same time frame.

chart
Click to Enlarge

This certainly looks to me as if the declining dollar tail is wagging the asset dog. Money held in dollars has flowed into stocks, gold, and oil as they become relatively “cheaper.” 

And you don’t want to fade this type of strong trend, as many bears have found when their paws keep getting trapped on days like Wednesday when we get huge gains in the markets.

NEXT: Weak Dollar is Good for Assets, but Bad for the Economy

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Long term, as I’ve stated many times, it is my view that a weak currency is not a good thing for an economy/country. The US economy has thrived many times in the past when we had a strong dollar. In fact, the risk of inflation grows as the dollar drops (and some may see this rally in stocks, gold, and oil as a form of asset inflation).

A weak/declining currency is a sign of a country with a poor balance sheet, and while we’re not yet at the point of no return or third world status, a collapsing currency is what has caused hyperinflation (and even revolutions/regime changes) historically in countries around the world.

Take a look at the Federal Reserve’s own long-term charts for the major currency index and broad currency index below (this and much additional good data is available for free download at the Federal Reserve Web site).

You can see that the major currency index in place since 1973 is on the verge of breaking to new all-time lows, although we haven’t yet eclipsed the lows of a couple years ago during the financial crisis.  Both of these dollar measures are clearly in sharp multi-year downtrends.

chart
Click to Enlarge

To see the loss of “wealth effect” for Americans, simply compare what traveling to continental Europe would cost now versus what it did ten years ago (and to the historical ranges of the currency exchange rates).

Remember that the euro was originally designed to trade around $1.00 and it stayed within a range of $0.80 to $1.20 for several years after it was created. It closed today at one euro = $1.45.

Similarly, the Japanese yen is currently very strong historically versus the dollar. Other currencies such as the Australian and Canadian dollars, both of which have big made gains against the US dollar, can be somewhat explained by the relative importance of natural resources to their economies.

So these are more countries where an American feels much “poorer” than he/she would have in the past. Some point to the possible short-term economic/earnings benefit that our exports will be cheaper with a weak currency, but the drawbacks far outweigh the benefits, in my view (and history generally backs this up).

In sum, as we always say, “The trend is your friend” when it comes to investing and trading. And the trend now is a declining dollar, which seems to be helping push many assets such as gold, oil, and even stocks higher.

So don’t fade the trend for now, but keep in mind that long term from a US citizen’s perspective, a weak currency is not a good thing for our standard of living and economy.

By Moby Waller of BigTrends.com

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