 US Dollar Bear
Intact
Adam Hamilton
Archives
Aug 28, 2004
One of the most fascinating enigmas of the markets this summer
has been the erratic behavior of the mighty US dollar. Since
this leading fiat paper continues to command world-reserve-currency
status, its machinations directly and indirectly affect countless
other markets.
Wall Street, which could easily
spin a bullish scenario even if a doomsday asteroid was about
to smash the world into oblivion, has its bases covered on dollar
movements. Whether the dollar goes up or down, the ministers
of financial propaganda in New York are convinced it will be
bullish for stocks.
They claim that a higher dollar
will increase foreign demand for US stocks, boosting stock prices.
At the same time they claim that a lower dollar will increase
the profits of major US exporters, boosting stock prices. The
perpetual all-bullish-all-the-time cacophony from Wall Street
leaves me shaking my head in amazement, but the Street always
has been little more than a marketing machine designed to help
dump stocks on the public regardless of valuation
or merit.
The red-hot oil market is also
affected by the dollar. The oil-exporting countries are acutely
aware of the dollar's value relative to other major currencies
like the euro. If the dollar continues its multi-year secular
bear market, they are going to do everything in their power to
hold back production to keep oil prices high in dollar terms.
The lower the dollar goes, the more dollars per barrel they will
demand to compensate them for the reduction in dollar purchasing
power.
While the relationships between
the dollar and stocks and the dollar and oil are often more indirect
than direct, the gold market has an indisputable direct
relationship with the dollar. Gold is a powerful hard-money currency
that competes directly with the dollar, so it tends to move inversely
with the dollar at least during this first stage of our current
gold bull market.
As a contrarian investor and
speculator heavily long gold, gold stocks, and gold-stock options
as this summer winds to a close, the near-term fortunes of the
dollar are of great interest to me. If the dollar manages to
extend its 2004 rally to new heights, everything precious-metals
related will almost certainly take a major hit. But if the dollar
reverts back into its bear-market mode of recent years, the precious-metals
sector ought to fly.
Since the dollar's coming course
is probably the single most important key for precious-metals
performance in the next few months, this week I wanted to reexamine
the dollar's strategic and tactical technicals. These charts
offer a great deal of evidence to help us determine whether the dollar bear
remains intact or whether we are likely witnessing a secular
trend change to a new dollar bull.
Both charts also include the
Relative Dollar, or the dollar divided by its own 200-day moving
average. This red line grants us an absolute normalized measurement
that does not skew over time regarding how the dollar has behaved
relative to its key 200dma. In secular bear markets like the
dollar's the 200dma forms the most important foundational overhead
resistance so the dollar's behavior relative to this line is
very revealing.
I know I am not the only one
interested in the dollar these days either, as my incoming e-mail
traffic in recent weeks has shown increasing nervousness among
precious-metals investors and speculators regarding the dollar's
apparent strength. Compounding this unease, an increasing number
of contrarian analysts are expecting major rallies in
the US Dollar Index that they claim could take it to anywhere
from 92 to 100 in the months ahead. Naturally this would not
be good news at all for precious metals if it really transpires.
The arguments for a renewed
dollar rally range from election manipulations by central banks
to the unwinding of various global carry trades to relative weakness
in other paper currencies. All of the dollar-bullish arguments
I have read are interesting, but the markets are ultimately a
study in probabilities. While the dollar-rally theories sound
plausible, are the odds really in their favor? These strategic
and tactical price charts below can help us sort through all
the dollar commentary and directly take the pulse of the dollar
itself.
This is the big strategic picture.
In the financial markets context is absolutely crucial and nothing
can quite put current price movements into their proper context
like seeing them within the prevailing secular, or long-term,
trend. In the dollar's case, this long-term trend is indisputably
down. This powerful dollar bear market has been underway
since the summer of 2001 and has yet to show any signs of abating.
One of the most important principles
for successful investing or long-term trading is the idea that
one should position their capital to run with the primary
trend. Long-term trends have tremendous inertia and they often
run for many years before ending. Unless big fundamental
changes are afoot, probabilities almost always favor the speculator
willing to bet with the primary trend.
In the dollar's strategic chart
above, its long-term trend is clearly bearish. Until the dollar
price rallies aggressively enough to convince us otherwise, in
this situation we must grant the dollar bear the benefit of the
doubt since probabilities continue to favor it. All of today's
theses for a major dollar rally just ahead are betting against
this primary dollar trend, a low-probability bet. Fighting the
primary trend is usually a losing strategy, except at rare secular
trend changes.
The reason that a major dollar
rally today is so improbable in technical terms, at least if
this secular bear has not yet given up its ghost, is due to the
dollar's current position within its downtrend channel. This
channel is defined by its lower support and upper resistance
lines. The primary problem with the dollar rally theses from
a technical standpoint is that the dollar is now crowding its
upper resistance line. If the dollar breaks out higher
from here it will power above multi-year resistance and cast
its entire secular bear trend into doubt.
A bet for a major rally today
is essentially a bet that the dollar bear may be ending. All
bears eventually end of course, so why should we give so much
credence and respect to these long-term dollar trendlines right
now?
Technically, the strategic
downtrend pipe shown above is really quite remarkable in its
precision. For several years now the dollar has cleanly bounced
between these support and resistance lines. On the low end the
dollar has intercepted its major support line multiple times,
and on the top end its major resistance has also witnessed multiple
intercepts. Other than the massive double top of early 2002,
the dollar has not traded significantly out of this trend channel
for years.
Since the dollar has not yet
been able to break out of this downtrend for its entire bear
market to date, odds are speculators around the world are closely
monitoring these long-term trends and continue to sell when the
dollar is near its upper resistance like today. With so much
history and precision inherent in this trend, probabilities favor
it continuing until some major fundamental change occurs that
signals the dollar bear's end. A technical rally today that moves
significantly outside of such a powerful strategic trend is really
a low-probability event.
And the longer that a secular
trend remains in force, the more it reveals about the power and
magnitude of the underlying fundamentals that are ultimately
driving it. The dollar's bear market exists because global dollar
supply exceeds global dollar demand. Is this fundamental situation
changing now or likely to change soon? This fundamental consideration
is very important since the implicit assumption necessary to
forecast a major dollar rally from here that breaks its bearish
downtrend is that the dollar bear market may be ending.
Secular trend changes require underlying fundamental changes.
Are we seeing a fundamental sea change to dollar bull-market
conditions?
On the supply side, the world
remains awash in dollars today. Not only does the goofy and irresponsible
Fed continue to print new dollars like there is no tomorrow,
but central banks and private investors around the world have
spent a half century accumulating dollars. The worldwide hoard
of dollars in paper and electronic form is absolutely enormous
and the Fed adds to this virtually every single day due to its
incessant fiat inflation. Dollar supplies are unlikely to shrink,
ever, as long as a Keynesian central bank controls it
and it is backed by nothing tangible like gold to impose discipline.
A perpetually rising supply
remains bearish for prices, so the only hope for the dollar bulls
is a vast increase in global dollar demand. On the contrary however,
various developments seem to be conspiring to lower dollar
demand around the globe.
The US stock markets, which
once drove global dollar demand as foreign investors were seduced
into chasing abnormally large US stock returns in the late 1990s,
are now in their ugly post-bubble bust phase. If history
is a valid guide, it will be decades before another
bubble in the general stock markets is witnessed. During this
bust the US economy is plodding along rather uninspiringly while
stock valuations gradually mean revert back down towards historical
fair value near 14x earnings.
At the same time alternative
global currencies are rising up that will eventually threaten
the dollar's hegemony as the world reserve currency. The young
euro, for example, has witnessed spectacular progress in the
short years since its birth. Already the dollar-laden Asian central
banks are reducing their dollar holdings to increase their euro
holdings, and some of the OPEC nations are even accepting settlement
of oil contracts in euros now. With both central banks and oil
exporters growing weary of the ongoing dollar bear, a major source
of dollar demand is fizzling.
The growing tide of Washington
DC's imperialism is also hurting dollar demand. Just like ordinary
people, nations don't appreciate other nations meddling in other
nations' business. Whether Washington was right or wrong to invade
two sovereign nations and install two puppet governments in recent
years, billions of people and scores of nations around the world
are furious about the new American imperialism. From the
Middle East to China, these people and nations are looking for
dollar alternatives since they are so disgusted with Washington.
This also reduces dollar demand.
On top of all this the dollar's
bear itself breeds a kind of self-fulfilling prophecy. Persistent
dollar weakness leads foreign investors to question just why
the dollar is weak. They eventually form an opinion which, correct
or incorrect, causes them to reduce their exposure to dollars.
Perception can become reality in the markets. This too
further reduces dollar demand.
So we have a bearish fundamental
situation here where the Fed is increasing dollar supplies at
the same time when central banks are diversifying out of dollars
which throws more dollars into the global market. And as the
US becomes a less attractive place for foreigners to invest in
during this supercycle bust, other currencies are rising at the
same time while Washington's imperialism retards global dollar
demand.
Any way you want to slice it,
it does not look like a major fundamental change
is afoot that is signaling the end of the dollar's secular bear.
On the contrary, the supply and demand fundamentals seem to be
greatly buttressing this ongoing bear. Rising supply plus slumping
demand equals lower dollar prices, period. In light of these
ugly fundamentals, the major breakout above the strategic downtrend
that would be necessary for a major dollar rally seems extremely
unlikely.
Now if the dollar was near
its lower support line today, as it was in early January when
I warned gold investors of a major
dollar rally approaching, then the case for a new dollar
rally would make sense within the context of its secular bear.
But with the dollar hugging its upper resistance today the case
for a dollar rally is very weak unless the dollar bear is ending,
and the supply-and-demand fundamentals just don't seem to be
turning around.
There have actually been four
major bear-market rallies in this dollar bear to date, as well
as four major downlegs which preceded them. All are numbered
in the chart above. Downlegs one through four registered respective
losses in the US Dollar Index of 13.4%, 9.9%, 9.6%, and 14.3%
for an average bear-to-date downleg loss of 11.8%. Bear-market
rallies one through four saw respective gains of 4.2%, 4.3%,
7.5%, and 8.2% for an average bear-market-rally gain of 6.1%.
The fourth major downleg and
its subsequent oversold bear-market rally are of special interest
to us today. Downleg four began in the autumn of 2003 and slid
all the way down from the top of the dollar's downtrend channel
to the bottom. This 14.3% loss in the US Dollar Index was its
biggest single downleg to date. This largest downleg was followed
by the largest bear-market rally, early 2004's 8.2% run higher
in the US Dollar Index. This move also carried the dollar all
the way back through its downtrend pipe, from its lower support
to its upper resistance.
And this brings us full circle
to today. The major rally in the dollar that some folks fear
has probably already happened in early 2004. In addition
to the dollar failing to break above its long-term strategic
resistance in recent months following the climax of this latest
bear rally, the dollar is also slamming into short-term tactical
resistance today. Our next graph zooms into the short-term technical
scene and highlights the dollar's plight from this tactical perspective.
This chart highlights the relentless
final plunge of the fourth major downleg of this secular dollar
bear and the subsequent fourth major bear-market rally. These
short-term tactical trends move within long-term strategic
trends. As you recall from above, all of the action on
this entire short-term price chart is contained within the dollar's
long-term downtrend. While not as important as strategic trends,
tactical trends are still very valuable for speculators to follow.
The biggest bear-market rally
in the dollar bear to date launched in early January with a sharp
V-bounce that is so typical of major interim bottoms. The dollar
surged higher before retreating in February, actually to a slightly
lower low which formed a double bottom. After that it was off
to the races, with the US Dollar Index powering relentlessly
higher into early May. This bear-rally uptrend is crystal clear
in this chart as the trendlines above reveal.
After briefly touching 92 in
early May though, the dollar witnessed its sharpest single decline
since its last downleg. It fell below its 200dma and then knifed
through its 50dma and out of its tactical uptrend channel. It
had a chance to recover and move back up into its uptrend as
it had in February and late March, but it couldn't pull off a
hat trick in May. By early June the dollar ground down to a new
lower low and its uptrend was decisively broken.
Since those lofty highs of
early May failed, the dollar has been in a very clear tactical
downtrend which is marked above. Both its tactical support and
resistance lines have witnessed multiple intercepts making for
a very well-defined trend channel. A central midline is also
forming, a halfway point in the trendpipe where the dollar can
bounce either way. For several reasons I suspect that this new
downtrend is actually the start of the fifth major downleg
of this secular dollar bear.
Technically, the dollar has
been unable to break decisively above either its strategic resistance
shown in the first graph or its tactical resistance in this second
graph. And after almost four months and three failed attempts,
I think the time of giving this dollar rally the benefit of the
doubt is long past. If the dollar was due to rally it should
not be having such a tough time breaking out of both short-term
and long-term resistance zones.
Second, the dollar has not
been able to trade decisively above its key 200-day moving average
for any significant amount of time. It has made several attempts
to break above this most foundational bear-market resistance
line, but so far it has failed. Technically a transition from
a bear to a bull absolutely requires the 200dma to be
broken and start heading higher, and the dollar hasn't even come
close to achieving this.
In fact, the dollar's 200dma
continues to slope rather sharply down, and a 200dma usually
runs parallel to a market's primary trend. A new dollar rally
from these levels would require the dollar to catapult through
its heavy 200dma resistance and march higher, and so far this
summer we have seen no confirmation whatsoever that there is
enough dollar demand out there to ignite such a breakout.
And speaking of demand, even
over the short-term the dollar supply seems to be growing much
faster than dollar demand. And one does not need to be an economics
professor to realize that a growing supply and flat to declining
demand inevitably leads to lower prices. The dollar apparently
remains in this very ill-fated boat right now.
The bottom line is the secular
dollar bear seems quite intact. Despite the growing chorus of
bullish commentary, even from within the contrarian community,
technicals and fundamentals just don't seem to support the dollar-rally
case. The dollar is banging its head bloody against the walls
at both its long-term and short-term resistance lines, not to
mention its 200dma, and it has just not been able to make headway
for the better part of four months now. This is a sign of bearish
weakness, not bullish strength.
If the dollar bear continues
as expected, it should be a great autumn and winter for precious-metals
investors and speculators. A falling dollar will almost certainly
lead to higher gold prices which we will continue to leverage
through carefully chosen elite unhedged gold and silver stocks
and gold-stock options. As always my specific existing and new
trading recommendations are available to our subscribers
in our acclaimed monthly Zeal
Intelligence newsletter.
Until the dollar can manage
to break decisively out of its short-term and long-term downtrend
channels, there is no reason to expect an abnormal rally that
throws this entire secular dollar bear into disarray.
And until a convincing case
can be made that dollar demand is growing faster than dollar
supply worldwide, there is no reason that we should expect this
secular dollar bear to end prematurely.
August 27, 2004
Adam Hamilton, CPA
email:
zelotes@zealllc.com
Archives
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