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US Dollar Rally Smacks Stocks, Oil and Gold


We’ve had a few big days of rallying in the dollar that have coincided with a bit of a pull back in stocks, oil and gold.

On the chart above, I have the price action in the dollar graphed out with the 13-day and 34-day moving averages. You can see that the red line (the 34-day moving average) has acted as the upper end of the downward trend in the dollar since the end of April. All the way down during this bear market, the dollar would sell off to a level below the 13-day moving average (the blue line) then rally up to the 34-day moving average. Today, we hit the 34-day average.

Will this moving average contain the rally much as it has for months? That’s a great question. Much of what will happen in all the markets this week will be determined by the Treasury Auction, as discussed in yesterday’s post. Today, we had the 2-year auction which went better than expected. My concern is still the 10 year and 30 year auctions which have yet to take place.

So, why is the dollar rallying? Higher yields make bonds more attractive in a relative comparison to stocks. We could be seeing a bit of movement into shorter term bonds from the stock market as some people are locking in their post-March gains. If that movement is by foreigners, they would need to buy dollars to buy the bonds, moving the price of the dollar up. Its just speculation as those statistics are not available, but one thing seems clear to me: the beta driven stock and bond market moves have run their course and we are on the cusp of a change to an alpha driven move.

What’s the difference? A beta move is one where the entire market moves up without consequence to individual investment fundamentals. Its the kind of move where index funds do well as they benefit from an overall lift in the market without the need to be able to discern between “good” and “bad” stocks and bonds.

An alpha driven move is one where the entire market (stocks or bonds) treads water or drifts lower, and the only way to move a portfolio up is by owning the “good” stocks and bonds. Alpha means that a professional money manager that knows what they are doing can have a significant impact on portfolio performance.

I’ll hopefully be writing more about this in coming weeks, particularly after our next Investment Strategies newsletter is published. But for now, we need to watch the treasury auction, particularly the 10 year and 30 year maturities to see if the world is willing to loan the US money for the long term and at what price.

We are definitely in a new era as the planet’s largest debtor who has to have the rest of the world buy our debt to keep solvent. At some point, our lenders will balk at providing us funding at low rates as our ability to repay (ie, repaying debt using a deteriorating currency that returns less than 100 cents on the dollar to the lender) will come into question and much higher interest rates will be demanded.

Steven Hess, Moody’s lead analyst for the U.S.A., said this late last week on Reuters TV (and reprinted in the Investor’s Business Daily):
“The AAA rating of the U.S. is not guaranteed. So if they don’t get the deficit down in the next 3-4 years to a sustainable level, then the rating will be in jeopardy.” No doubt leading to higher rates.

Good times…