October 29: Back With Dollar Updates...

First, Happy Anniversary of the 1929 Stock Market Crash!

Looks like we're finally getting that dollar rally.  Over the course of the last few days, the number of deflationists, "this is it"ers and permabears have come rolling out of the woodwork exclaiming that we're in for the next big crash down.

In short, we don't think we're there--at least not yet.  In fact, we think this dollar rally is just about over over and the down trend will soon resume.  This means it's time to get ready to purchase assets while they have depressed prices, as soon as it's clear that the trend is turning over and the asset inflation trend is resuming.

US Dollar
First, let's recap things at a high level.  It is our central thesis that the dollar rules all as can be repeatedly found throughout the Technical section.  As long as the correlation between general asset prices and the dollar continues, we look to the dollar first for indications on what's to come.  That correlation has been in place since the beginning of this decade, and though we anticipate that it will have to fall apart at some point, it hasn't yet.  Thus, as the dollar moves down, commodities and stocks tend to move up.  Until we see a definitive trend change, the dollar index needs to be watched to determine the rise and fall of asset prices (keeping in mind that we must differentiate currency fluctuations and inflation, but for the time being, the USDX is the most relevant forecaster of asset pricing.)


Though we cover it repeatedly, a longer term view of the US dollar index is relevant as a starting point.  Below is a three year, weekly chart of the dollar.  The area from roughly March 2008 - March 2009, boxed in red, is the period of the credit crisis (see Looking Back at Signs of the Credit Crisis for more information).  On this three year chart, we can see behavior of the dollar before, during, and after that period.

Some very interesting observations are at hand.  First, the dollar never broke 50 on our RSI indicator (top of the chart) until the dollar broke out of its consolidation phase.  Going forward, a rise above 50 on the weekly RSI is a good indicator of a serious situation at hand.  Both before and after that event, once the RSI was below 50, 50 has acted as the ceiling.  Note that we're well below that now, indicating that a longer term rally for the dollar is going to happen.  However, we do not believe that will occur until the dollar reaches the 72 level.  Thus the question is when this small dollar rally will end.

Below is a three year chart of the daily dollar index, again with the "credit crisis period" blocked off.  We can see that the daily RSI, prior to the credit crisis, could not penetrate the 65-ish level, and every time the RSI went below 30, the dollar had a "small rally."  This was true until the credit crisis period, and since that event ended, the RSI has struggled to get above 50.  The blue vertical lines show the consistency of a rally when the dollar touched 30 or fell below it.  It has been an extremely reliable indicator for the dollar rallies and plunges outside of the credit crisis period.

Below is a zoom-in on the above chart, limited to an 18-month window.  Again, we can see the consistency with which the RSI "calls the top" on the dollar rallies.  Note again the blue lines that indicate both the lines of resistance for the dollar and denote the falling wedge formation that we originally discussed in early October.  A break above the wedge (aka, a "breakout") would signify that a more substantial rally was afoot. However, given that the dollar is coming out of a double top, and earlier descending triangle pattern (both very reliable), we should not see the dollar break out too strongly until it completes its pattern, somewhere in the 70-72 range.  As a result of this, we have been expecting a short term rally in the 76 range that would set up a buying opportunity as the dollar moved between 76 and 72.

Now that we've finally gotten our rally, what should we now expect?

A short term view of the dollar shows the continual pattern of support, false breakdown, short rally, and resumption of a plunge.  We are setting up another flag/pennant formation, just as we did in early October.  The dollar is up against the 50 level in the RSI and is approaching overbought on the slow stochastic.  The 50 day moving average looms as a continual ceiling to the dollar's movement.  At this stage, we expect that the dollar rally is about out of steam.  The dollar may move sideways for a few days, possibly all of next week, and then resume its plunge.  IF the dollar breaks up above the 50 day moving average or above 50 on the daily RSI, that would be a sign of a potentially larger rally developing.  That would force us to get liquid.  Again, though, we do not expect to see that until the dollar reaches the 70-72 range.

We wrote about a way to play this move at the beginning of the month.  It certainly moved developed more slowly than we anticipated, but it's here.  We believe that once the dollar shows signs of reversing and going lower (today's a great example as the intraday low is below 76 again), it will be time to buy key assets and wait for the down move and resulting rally.  Get your finger on the trigger.  We're in the buying zone and would only liquidate if the dollar breaks the 50 dma and the RSI rises above 50.  We will go short on select assets if they break key support levels--no need to catch 100% of the move if we can minimize the risks.