The value of money and commodities

Shawn Hackett
Published 02/01/2011

The U.S. dollar uptrend that began in the fall of 2010 may accelerate in the first half of 2011. The bullish fundamentals for the dollar, which led to its recent strength, remain in place and will likely push the greenback higher in the new year. They are as follows:

1) The Chinese are in the process of popping their real estate bubble, infrastructure bubble and currency distortion bubble (inflation). They really have no choice but to do so for their long-term health. They are doing everything they can to pop this unhealthy situation, and pop it they will. It would not be a surprise to see them let the Renminbi rise substantially as well. In a nutshell, Chinese consumers need to save less, spend more and the country needs to retool their economy. A slowing Chinese economy also will pop the real estate bubbles in Australia and Canada, as well as drag down the commodity-related economies of Brazil and Russia. All of this will be hugely U.S. dollar bullish as differentially the U.S. economy will be on a much more stable footing in the first half of 2011.

2) Europe likely will have to address debt defaults in Spain and Italy in the first half of 2011, which will continue to be a destabilizing force to the euro currency and be very supportive to the U.S. dollar.

3) Japan has an even bigger problem in their overall debt levels with a collapsing demographic profile that likely will support a policy to weaken the yen to provide support for exports as they continue to delay the ultimate day of reckoning. A weaker yen will be very supportive to the dollar.

The reason that a further strengthening of the U.S. dollar likely will be so detrimental to overall commodities has more to do with sentiment than it has to do with the actual shift in supply/demand stemming from a rising dollar. Take a look at the unprecedented, overextended and anomalous overbought/bullish condition of the Continuous Commodity Index (CCI) as measured by the weekly MACD (see "Time for a change"). The current overbought condition of the CCI has surpassed what was seen in 2008 just before the crash occurred.

With the current level of bullishness in the CCI at over 50-year highs, the current psychology of the commodity markets is very vulnerable to anything that might turn that sentiment even slightly less bullish. A rising U.S. dollar, in response to a slowing global economy, would cause the current nosebleed levels of speculative long positions to quickly look to get out of the exits all at the same time. With only one way out, the relentless selling and escalating margin calls will conspire to create temporarily crashing markets and continue dollar strengthening.

Currently, the Chinese stock market is falling while commodities continue to surge. Such a divergence in what is normally a very correlated asset relationship is a warning sign that something is not right with the Chinese economy; eventually this reality will be priced into commodities with much lower prices as demand-side expectations get downgraded. The last time this kind of divergence took place was in late 2007 and persisted to mid 2008, just before the commodities crashed and the global economy, including the Chinese economy, hit a major roadblock. "What about the dollar" shows this and how the dollar reacted.

Given the potential to test the early 2009 high, a long position in the dollar index can be put on just above 80 with a relatively close stop at 78.50.