Thursday, September 24, 2009

U.S. Dollar: Global Punching Bag No More

“When everyone gets on the same side of the boat, the result is inevitable.” D. R. Barton, Jr. Van Tharp Institute of Trading Mastery

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There have been many anecdotally famous instances of popular and widespread opinion moving so far to one side that a reversal of an extreme trend was bound to follow.

I still remember watching CNBC in the fall of 2002 when Maria Bartiromo made her famous comment from the floor of the NYSE along the lines that she was hearing indications that there was a lot of short selling going on. While Bartiromo’s comments weren’t the catalyst of the market turn, they were indicative of the common wisdom that once an idea hits the mainstream media, the trend is near its end.

The same thing happens in the general public. I wrote an article last year in June talking about seven different and unrelated people that had spoken to me about the price of oil or gas. These were not financial people; these were folks at grocery stores and schools. The market topped in a matter of weeks.

Lately, in the financial press, the declining dollar is making headlines everywhere, though the buzz is not so high among the population in general. Nobody has approached me recently with concerns about this because most Americans don’t feel directly the decline of the dollar in their day to day lives—unless they travel abroad.

To find out if the falling dollar headlines of late are a measure of popular sentiment and a possible trend reversal indicator, I needed to get input from a group of people who might know and care about the dollar’s relative value.

O Canada, How Concerned You Are About Investing in the U.S.

Every year, we have a large number of Canadians that attend our workshops. (As a quick aside, is there a friendlier group of people on the planet? I think not. Conde Nast magazine agrees: they ranked Canada at the top of the list of friendliest countries to visit in the world. Yet I digress.)

In the recent months, I have had no fewer than half a dozen personal requests from Canadians asking about hedging their investments in U.S. instruments. And it’s little wonder; since the March highs, the dollar has gone from $1.30 for every Canadian dollar down to just $1.07.

And when that many people start to ask about the dollar’s movement, it’s time to gear up for a move back in the other direction.

While it’s no secret that the U.S. dollar is at the whipping post of almost every media pundit, some of the smartest folks I know are now actively looking for the right timing to invest in exactly the opposite direction—dollar strength.

This is probably not a multi-year reversal. Rather it reflects research that shows many of the factors that have weakened the dollar over the past six months are now diminishing. Along with that, the natural rhythm of ups and downs will take the dollar back up.

Smart Guys, Great Analysis, Useful Conclusions

In March of this year, my best friend and business partner Christopher Castroviejo introduced me to a friend of 25 years, Marshall Auerback. Marshall is one of the owners of the RAB Capital hedge fund group.

Over a dinner of spectacular food and wine, I immediately knew that the depth of intellect as well as the breadth of knowledge at the table was something that few people get to experience in their whole life.

Christopher, Marshall and I traversed subjects from bonds to gold to crude to domestic and global markets. And then we were into U.S. and global governmental policy and stability. We diverted to wine and fine foods. And we topped it off with some talk of football, baseball, basketball and golf. All of these diverse subjects were taken to a level of depth and detail that is hard to believe. These guys are wicked smart and extremely well read.

So when Marshall or Christopher has to something to say, I always listen closely. And when they’re both on the same side of a financial issue, one would be ill advised to be on the other side for very long.

This brings me back to the dollar. Marshall wrote such a well-reasoned and concise piece on the dollar this week that I wanted to share the highlights with you. The bottom line is that he’s looking for a dollar rally soon.

* For the current recession, the decline in the U.S. Gross Domestic Product (GDP) has been much smaller than in the European or Japanese GDP.

* Some members of the Federal Open Market Committee (FOMC) are expected to launch a campaign in favor of ending the Fed’s highly accommodating emergency policy stance. This would mean marginally or significantly higher interest rates in U.S. over time, which would lead to a stronger dollar. Just the anticipation of this being made widely known would be a strong net positive for the dollar.

* Speculation that the dollar is being used as a funding source for an interest “carry trade” is absurd. (The carry trade means borrowing a low interest currency to invest in currencies paying higher interest and pocketing the difference). If this trade were happening, it does not describe what is happening with dollar relative to lower yielding currencies (e.g., the Yen or the Euro, which has slightly higher short-term rates and slightly lower long-term rates).

Marshall concludes with this a great summary that I’ve paraphrased here: My experience is that when extreme sentiment reverses and there is a new simple story at hand, trending bandwagon markets can reverse in a quite violent way.

Marshall is the first to agree that the timing on this trend reversal is a touchy matter; it could be today, it could take weeks or more to develop. But when extremely smart and successful money managers give us such well-reasoned thoughts, it usually pays to listen.

About D.R. Barton, Jr.: A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena. He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on and Financial Advisor magazine. You may contact D.R. the Van Tharp Institute of Trading Mastery