Major US Dollar Rally Is Coming

10/04/2011 3:30 pm EST

Focus: FOREX

John Carter

Author, Mastering the Trade

The US dollar is primed for a major move into 2012, says John Carter, who explains the huge impact this will have on global equity and commodity markets, and how traders can play the move using options, ETFs, and more.

A lot more traders are trading the US dollar, but even if you’re not a dollar trader directly, you’re probably watching it even if you’re an equities or a futures trader.

Our guest is John Carter from Trade the Markets. So, John, talk about the dollar, where you see it headed, and why it is such a popular trade instrument these days.

The first thing, of course, is the dollar is the major instrument that a lot of currency traders are trading against—the euro/dollar, the Canadian dollar, etc. The big thing right now, and the consensus is fundamentally that the US has a lot of debt—$14 trillion and counting every single day—and that the US dollar is going to get weaker and weaker and fall.

Well, that’s not going to be happening over the next several months. As we head into the rest of 2011 and into early 2012, the dollar is actually going to continue to get stronger and stronger, and that has a lot to do with a global recession that’s coming down the pipeline.

What happens in a situation like this is when there is a global recession, when all the economies of the world are slowing down, everybody looks at all the fiat currencies and says, “Well which is the one we want to own?”

The one that you want to own is the one that’s also representing the largest GDP, which is the US dollar. The US economy is bigger than the next four largest economies combined.

Now, this goes across the conventional wisdom, so what’s going to happen is with a stronger dollar, you’re going to see gold get hammered, you’re going to see silver get hammered, you’re going to see the euro, obviously, get hammered. Actually, all commodities will get hammered.

Jim Rogers is going to be having to take a lot of Tums over the next several weeks, because I know he’s such a commodity bull. Long term, yes, that makes sense, but over the next four to six months, the dollar is going to be so strong that you’re going to see all these commodities—oil, grains, gold, silver, things like that—getting hammered as well.

Now, a trader who does not realize this is going to have a big problem whether they’re trading forex and keep trying to buy these dips on the euro because they think that the euro is going to go higher against the dollar. They’re going to have a big problem.

So, on something like this, I like to know the fundamental picture and then match it up with the technical picture, and then be able to take trades against that.

So, John, what levels of price are you looking for and have you been watching here in the dollar?

The key level is 76.50. Within the last four months, we’ve been trading between 76.50 and 74.50. We’re going to break out through 76.50 on the up side. We’ve got some weekly signals that are coming together that once we break out through there, we’re looking at a test of 80 at the very first level, and then from there we could get up to 84 to 85 on the dollar index.

The corresponding level on the euro is down to 1.20, so I’m looking for the euro to get completely hammered during this event.

Alright, so the trades we should actually be putting on; should I be short the euro and how do I do that, and how do I go long the dollar? Is it a spot trade; is it a futures trade? What is it?

There are a couple ways to do it. The low-risk way to do it is to use options. So, an exchange traded fund called the CurrencyShares Euro Trust (FXE), and that represents the euro. So, you could buy put options on FXE.

With a put option you’ve got limited risk. You buy the in-the-money put options for November and December and you just hold onto it. That’s going to mirror what’s going on in the euro.

There’s also a symbol called PowerShares DB US Dollar Index Bullish Fund (UUP), and that’s the dollar index, the exchange traded fund for the dollar index, and you could buy call options on that.

If you are a currency trader and you are familiar with the spot market, of course, you can short the euro. That’s the one that has the most direct correlation against the dollar.

You can also on the futures market short the euro futures, and you can actually buy the dollar index as well.

For all those trades, once it starts breaking out, you can also sit there. If the dollar index breaks out, you can buy the pullbacks, or just try to ride it out. This is going to be a big move.

Alright, then finally, how will that dollar strength effect equities markets overall?

Well, it’s an interesting question on that because a lot of people don’t understand that the relationship between the dollar and the equities changes over time.

What the big relationship is right now is that the dollar—much like the yen—is a carry trade currency of choice. So people (hedge funds) borrow dollars and borrow yen at low interest. Then they go put them in aussie dollars at high interest, and then they use that margin to go buy other assets; gold, silver, stocks.

Dollar higher means that they have to unwind that carry trade. That means they have to dump all the assets that they borrowed against. That means stocks are going to get killed.

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