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Stay Flexible


Gold, silver, energy are out. Bounces in dollar, equities are in.


I have been anticipating a bounce in the US dollar index even while expecting the U.S. dollar to trade lower vs. the Yen.

Many have asked why. The answer centers around a dislike of the Euro and British Pound. So before proceeding with thoughts about flexibility, let's stop for a moment and take a look at a few of my reasons to dislike the Euro and the Pound vs. the US dollar.

  • German banks are arguably as bad off if not worse than U.S. banks.
  • Property bubbles in parts of the Eurozone are worse than in the U.S., Spain being the primary example.
  • The property bubble in the U.K. is as bad if not worse than the U.S.
  • Anti-dollar sentiment is extreme.
  • The Euro has benefited from a huge diversification out of dollars, especially from oil producing states. At some point diversification will end.
  • There is still a prevailing attitude that the U.S. will enter recession and somehow the Eurozone and U.K. will avoid that recession. I do not support that view.
  • There is a prevailing attitude that Bernanke will keep slashing rates to zero while the ECB will hold the line. I suspect the ECB will start cutting rates and at some point the Federal Reserve will pause to consider.

However, opinions are opinions and facts are facts. The fact is the Euro rocketed higher, and the fact is I have been surprised by the resolve of Trichet in holding the line at the ECB. Indeed, the willingness of the ECB to hold the line may account for that last blast higher on the Euro. Can the ECB hold out forever? I don't think so, but that is an opinion, not a fact.

As for Bernanke, here is the key question: Will he pause for more data or will he continue nonstop on a path to zero interest rate policy (ZIRP)? Perhaps we have a clue in two dissenting votes at the last Federal Open Market Commitee (FOMC) meeting.

Viewpoints vs. Trading Positions

It's one thing to have a viewpoint and it's a second thing to actually trade that viewpoint. Can one have a viewpoint and not trade it? Of course.

I have had no personal stake in currencies for a long time. I seldom trade currencies even though I frequently have a viewpoint about them.

Sitka Pacific Capital Management, the firm I represent, does trade currencies (in a small portion of one particular strategy). Recently we were long the Yen vs. the U.S. dollar and did very well with the trade. But that position was closed and as of March 19 my firm went long the U.S. dollar index via UUP. Here is a chart of the U.S. Dollar index to consider.

US Dollar Daily Chart

Click to enlarge

Inquiring minds may be asking "Was there any reason to buy that second circled area above vs. the first?" The answer is yes, there was a reason. The reason has to do with intermarket analysis of gold, the Euro, and the dollar. Let's start with a chart of the Euro.

$XEU Euro Daily

Click to enlarge

Given that the Euro is by far the largest component of the U.S. Dollar index at 57.6% it does not make a lot of sense to go long the U.S. Dollar index until it looks like the Euro is headed lower vs. the dollar.

I circled a trendline break above, but there were three prior trendline breaks in the channel drawn. So what makes this the correct one?

Gold Confirmation Context

Click to enlarge

Heading into the end of 2007, the triangle continuation pattern in the above chart suggested gold would break up, and if it did, the Euro channel would likely resolve to the upside.

In contrast, Sitka Pacific's long U.S. dollar trade was initiated on a break in the Euro confirmed by a break in gold.

However, my firm anticipated the break in gold first, and in fact exited gold (GLD) positions near $980 on the way up, not on the way down. Why?

  • Sentiment in gold seemed to be hitting extremes.
  • Seasonality

The latter was a key factor. Gold tends to peak in a January-February timeframe. The seasonal peak season is usually August through January or February. In this case it ran through mid-March. However, with gold at or near $1000, and with favorable seasonality expected to end anytime, the risk-reward scenario simply did not look good to me, and the Euro looked extended.

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No positions in stocks mentioned.
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