Wednesday, June 15, 2011

Is it time to buy the US Dollar?

There are riots in the streets of Greece, which now has the lowest credit rating of any sovereign nation on earth. Remarkably, the Euro Zone has managed to weather the storm quite well.  Whether it can continue is another matter.

The European Facade maybe Crumbling

A look at the US Dollar Index and the US dollar / euro exchange rate certainly points in that direction. As bad as things appear to be in the USA, Europe seems to be more worse off. 

The European Union is made up of 17 countries who speak different languages, have different customs and have varying degrees of work ethics and national productivity levels. 

As split as the US is between liberal and conservative views, the people are still all Americans - even if they come in all shades and shapes.  As such Americans have far more in common with one another than the 17 nation Europeans do.  If one of the states in the  USA gets into trouble, people won't be rioting in the streets if the Federal government decides to bail them out.

Now let’s consider it from the European point of view: If you are the German Chancellor, how do you defend the diverting of your national wealth to support a country such as Greece, when your electorate holds the firm view that the Greeks are neither as hard working nor as fiscally responsible as the average German? Correctly or not this appears to be the view reportedly held by much of the German public.

This puts Angela Merkel in quite a political situation. If the so-called PIIGS (Portugal, Ireland, Italy, Greece and Spain) follow Greece, it would be a miracle if the European Union survived intact. This fear is what has been behind the bull market we have seen in US bonds over the last six or so weeks, because, on a relative basis, US Treasuries still look like a much safer bet than EU Sovereign debt.

So, how can we benefit?

I know it's in vogue or even cool to be totally negative on the dollar, but to me, the dollar looks like it wants to rally. The US Dollar Index (DXY) is a basket of 6 currencies measured against the US dollar.  The biggest component by far is the euro, which makes up 58.6% of the index. Any drop in the euro will push up the value of the dollar, which in turn will drive the US Dollar Index higher.

If we get a real increase in Euro-related fear, we could easily see the US Dollar Index hit 80 - 81. Those looking to go long the dollar could do so by either buying the front month US Dollar Index futures contract (DXU11), or via the Bullish Dollar ETF, symbol UUP. 

So if I’m going long, I would use a break below 74.50 on the US Dollar Index as my stop point. In fact, if the US Dollar Index breaks that level, I'd be inclined to switch my entire strategy and look to going short for a  bit.  Anybody who tells you that they know with 100% conviction what the future will be is either fooling themselves or attempting to con you into something nasty.

Another way of playing a rising dollar is to take some bets directly against other currencies. One such currency is the Australian Dollar. I doubt if there is another developed country (except maybe Canada) that is more leveraged to the price of commodities. Remember, global commodities are priced in US Dollars -- if the value of the Dollar goes up, commodities typically go down. As commodities go down, the value of the Australian Dollar will typically decline as well. I would go short the Australian dollar in the futures market. The symbol on the front month contract is ADU11.  I'd use a move above 1.0730 as my stop if I’m short, with a price target of say 1.0275.  Alternatively, I could use the Australian Dollar currency ETF, symbol FXA.  If I’m using FXA to go short, I’d be sure to track the movement of the front month futures contract. I’d use the levels in the actual futures contract to trigger any profit taking and stop loss decisions in the ETF.

Remember, the whole world is looking for the US dollar to collapse into oblivion. I don’t consider it likely that everyone will be right. May the trend be with you always...