The Best Current Short Dollar Trade Currently in the Market

All may seem calm to the casual observer, and there may even be indications of a recovery: the Dow and S&P have outperformed Treasury bonds and precious metals, and the dollar has remained stable. Is this the beginning of a new bull market? Is it time for permabears to pack it up and go home? The chart below illustrates the situation.

To my fellow permabears: fear not, for contrary to what the always happy-go-lucky bulls may think, this is simply a rally within a bear market. Short-term traders may find it enjoyable, but the buy and holders? Well, now remains a good time to continue accruing precious metals.

But for traders like myself who are always looking for opportunities to trade their long-term perspective, know that the market is currently giving us a very good opportunity. Inflationists/Dollar bears have been eyeing commodities, and on the Australian dollar and the Canadian dollar -- currencies closely correlated with commodities.

Check the chart below on the Australian dollar.

And the chart below on the Canadian dollar.

Trading This Setup

I've already entered a short USDCAD trade, and will be scaling into this position as it moves in my favor. I would like to see a test of the 1.05 area. I'll add on the break below each key level, and will close out if there are signs the trend has reversed or is stagnating.

Simit Patel
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The Road to Hyperinflation

As most of us who have been watching the financial markets know, yesterday was quite a day. The Federal Reserve announced they would print money to buy Treasuries and mortgage-backed securities.

The Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.

The market promptly responded:

1. Gold shot up and stayed up; it is currently trading at $958 at the time of this writing. Silver is rallying as well, trading at $13.48 per ounce at the time of this writing.
2. The US dollar dropped sharply against all other major currencies.
3. Crude oil rallied above $50 per barrel.
4. Treasuries rallied.

From these events, we can deduce two things:

1. The Fed is clearly aggressively pursuing its an inflationary monetary policy. This is further evidence that the Fed can do what it wants; if the Fed is truly determined to inflate, it will be able to do so, regardless of whether or not banks will lend. Monetary policy is a fiat matter.

2. The market is clearly willing to run from the dollar in the face of outright monetization.

As money supply is expanding while demand for US dollars is collapsing, and as dissatisfaction with the political environment in the United States is at a nearly unprecedented level, it is clear the ingredients for hyperinflation are in place. See our previous analysis of hyperinflation for a more detailed explanation.

Moreover, CPI data released yesterday by the Labor Department in the US noted that consumer prices rose for the second consecutive month. Should this trend continue, it sets the stage for a price/wage spiral, whereby higher prices lead to higher wages, which in turn lead to higher prices, and so. Declines in demand due to higher prices may not be sufficient to stop prices from rising further should the Fed continue an inflationary policy.

The New Trading Environment

As we have discussed before, "playing defense" against monetary policy is crucial to wealth preservation in a centrally planned economy. Based on the signals the market and the monetary authorities have recently given us, here are some trading thoughts for the near future:

1. Gold and silver. I've advocated precious metals many times before, and continue to do so, as they are the conventional inflation hedge, and remain the market's monetary commodities of choice.

2. As the Fed is distorting the free market process in the Treasury market through intervention, Treasuries may be difficult to trade without technical analysis.

3. Watch oil. Should it continue to rise, which seems very likely to me, it would be further evidence of an inflationary spiral, as rising oil prices will lead to rising gas prices, which in turn will lead to rising prices, and a demand for rising wages. With that said, I find oil's behavior a bit perplexing, and thus I personally favor precious metals as an inflation hedge. Those with a larger capital base and a need to diversify, though, may seek solace in oil.

4. The stock market remains a trader's environment, even more so than before. Those who can use technical analysis to understand momentum will be best positioned to find profits in the stock market, in my opinion. Fundamental analysis will be less effective, as the Fed's interventionist behavior will make rational analysis difficult and perhaps fruitless.

Disclosure: Long gold and silver.

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The Case for the Australian Dollar as a Long-Term Trade

One of my favorite currencies on a three year outlook is the Australian dollar. There are three reasons for this:

1. In light of the increase in US government spending and the diminishing tax base, I think substantial dollar devaluation is likely over the next 3-4 years. This increases pressure to "decouple" -- specifically for China to discontinue buying US Treasury bonds, and to invest that capital into its own economy, which it has been doing. As China invests more in its own domestic economy, it will boost the economies of geographically related countries that can export necessary commodities to China. That's where Australia comes in.

2. Australia's central bank, the Reserve Bank of Australia, currently has an interest rate target of 3.25%. In a world where zero percent interest rates are becoming the norm, this is quite appealing, and may attract capital that is seeking the security and liquidity of a currency but with an interest rate yield as well. Put another way, the Australian dollar could be the new carry trade.

3. The Australian economy has, at least for now, remained relatively unscathed by the global economic crisis. In Australia, wages are up, business investments are up, retail sales are increasing, the housing sector is expanding, and the country si running a trade surplus.

In light of the aforementioned, the Australian Dollar seems like a viable long-term alternative to the British pound and the US dollar.

Trading the Australian Dollar

Personally I've been riding the recent short-term rally in AUDJPY (Australian dollar against the Japanese yen), though price action is suggesting this rally may be out of steam in the short-term. Patient traders, though, may wish to keep an eye on AUDUSD and look to enter as momentum turns upwards. The chart below illustrates key price points that can serve as areas where prices may consolidate -- and thus where traders can look to enter or exit positions.

Disclosure: Long Australian dollar.

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Demystifing What Gold is Telling Us

Well, gold bugs around the world have been having a good chuckle of late, as the market is re-affirming the often eccentric and religious-esque views of gold bugs: gold is up over 11% for the year in US dollars, and up over 4% over just the past five trading days. Which begs the question: why? There are a few possible answers to this question:

1. Deflation. This crisis is global, and everyone is flying to safe stores of wealth. Over the big picture of human history, gold has served as the best store of wealth -- and thus gold is rising. In many ways this is the classic "gold is money" argument, one typically championed by Austrian economists. Robert Blumen has offered an excellent explanation of this argument.
2. Inflation. Gold is typically a hedge against inflation concerns, and as the US federal government continues to aggressively "stimulate" the economy, the rally in gold may be a reflection of increased concerns regarding inflation.

So which one is it?

In my opinion, both. With that said, I view inflation as the larger concern, as I have said many times before. If the environment were truly deflationary, Treasury bonds would be the true recipients of flight to quality, as well as dollar holdings in FDIC insured banks. Instead, 20+ year Treasury bonds have fallen by more than 13% thus far (as measured by TLT). Negative correlation between TLT and precious metals suggests inflation, not deflation. The chart below illustrates.

Deflationists will point to the fact that the US dollar may be strengthening relative to other fiat currencies -- although this is not necessarily a reflection of deflation, as it could simply be interpreted as weakness of all global currencies, all of which are falling against gold. More relevant may be the rise in PPI and energy prices in January of 2009. While one month alone does not provide sufficient evidence for a substantive reversal in macroeconomic trends, it is not consistent with deflation, and may suggest that the Fed's inflationary actions in the second half of 2008 may be kicking in.

Conclusions for Trading

The recent activity in the market has led me to make the following revisions:

1. The forex market is increasingly a trader's environment, perhaps even a daytrader's environment.
2. Gold and silver may retrace, perhaps even by several hundred dollars, though I would view it as an opportunity to buy on dips. The global economy is getting worse and conditions are being aggravated by the actions of central bankers. As a result, the fundamental case for gold and silver will get stronger.
3. Counterparty risk is rising -- this strengthens the argument for increasing the physical delivery portion of one's precious metals portfolio.
4. Because of inflation concerns, my bias is against short positions in all asset classes. If I were a trader of stocks or commodities, I might look into shorting positions relative to a broader index (i.e. short a particular stock while going long the sector ETF, under the rationale that the stock will do worse than the entire sector).
5. Oil's behavior has been quite peculiar; I've yet to find a convincing explanation for why it's moving the way it is. As it escapes my fundamental analysis, and as I find it less appealing than currencies from a technical analysis perspective, I'll stay away from oil.
6. As gold becomes too expensive for many, silver will grow in appeal. And as silver fell more than gold during the second half of 2008, it may be set for a larger rally.

Disclosure: Long gold and silver.

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Copper And Base Metals May Be Good Way to Profit from Inflation

Copper has become a renewed subject of interest, as some market prognosticators view copper as a leading indicator of the economy as a whole. This results from the fact that copper is used in a wide variety of businesses -- industrial products, semiconductors, infrastructure, etc. -- and thus changes in copper prices can signal big changes in sectors that are copper-dependent. Currently, copper prices are rising, which could be interpreted as businesses showing an interest in buying copper because of an increased willingness to assume risk and invest in certain sectors of the economy.

The chart below illustrates. The transportation and semiconductor sectors tend to be particularly dependent upon copper, and thus included ETFs that track them (XSD for semiconductors and IYT for transportation) in the chart below; we may be able to learn more about which sectors in particular are moving.

While semiconductors have been rallying since mid-November, the transportation sector continues to be devalued. Moreover, the overall demand for copper is declining around the world, as this Bloomberg article notes, and has decreased copper mining efforts.

As platinum, silver, and gold continue to rise while Treasuries continue to fall, copper's rally may signify greater inflation concerns. As metals have rallied while commodities have remained stagnant, the market may be signalling greater concerns about inflation in the midst of a lack of investment opportunities.

Thoughts on Trading

Copper has taken a particularly harsh beating thus far, as the chart above illustrates. As such, the bottom identified in the chart may be a critical level to watch to gauge broader macroeconomic trends; a break of that level could signify the next leg down for equities.

Conversely, copper may be a better play for those looking to profit from reflation of the money supply. As copper has fallen more than many other metals since falling asset prices set in in August of 2008, it may be due for a larger correction.

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A Bull Market in Stocks Could Result from Significant Inflation

Puru Saxena of Money Matters recently wrote an article entitled "Birth of a New Cyclical Bull?" in which he offers arguments for why we may see 2009 be a bullish year for equities. His basic points:

• Inflationary actions by the Fed and declining TED Spread have proven effective in fighting falling asset prices and reducing risk
• Treasury bonds need to have higher yields or money will go into equities
• Equities have "overshot" to the downside, thus resulting in excessively low valuations

I agree with Saxena's basic premise that the Fed's actions will be successful in creating in inflation in the aggregate; it is only a matter of which asset class will reap the benefits of the inflation, and who will pay for it.

The chart below compares various asset classes against one another for the month of January.

A key question we may wish to begin asking and examining is just how much inflation the Fed has really created for us, something that will become more apparent as lending resumes and money that is "on the sidelines" returns to the game. I'm of the viewpoint that the global economy is currently improperly structured, and needs a complete restructuring, one that will likely require abandonment of the US dollar as world reserve currency, a corresponding decline in US consumption, and a significant restructuring of the FIRE (finance, insurance, real estate) economy in the United States. From that perspective, an equities rally will be unsustainable, unless there is currency debasement to the extent that all markets rise nominally. If that is the case, though, the inflation will result in significant dollar devaluation.

Trading Implications

The fall in Treasuries was the story for January, and will be of importance so long as it continues. If money comes out of Treasuries and into equities and commodities, it increases the likelihood of seeing consumer price inflation. As I've stated before, though, I expect commodities to outperform equities once money comes out of Treasuries and dollar devaluation resumes. And as all currencies around the world are having trouble, gold will continue to rise as fiat currencies continue to struggle.

Disclosure: Long gold.

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Money Coming Out of Treasuries And Into Gold

To understand how the macroeconomic picture is changing, we can take a look at how various asset classes are changing relative to one another. With that in mind, see the chart below, which shows the ETFs for four asset classes -- Treasuries, gold, commodities, and the S&P 500 -- to see where money is moving.

The chart illustrates the following:

• 20+ year Treasury bonds were rising, but now appear to be consolidating and possibly turning bearish
• S&P is rangebound between 850 and 950
• Gold is rallying
• Commodities are still in a bear trend

Interpretation

The rise in gold coupled with weakening Treasury bonds, commodities, and S&P suggests the market is still rooting out false forms of wealth -- and that the market is shifting to gold as its preferred method of safety. Inflationists will posit that the rise in gold results from greater inflation concerns, and this may play a part into it as well; money supply indicators and money velocity indicators are both pointing to inflation.

Trade Setups

Two potential trade opportunities come to mind:

1. Betting on a continued exodus from Treasuries into gold, in that the market will continue to favor gold over Treasuries as a safe haven
2. Long commodities relative to S&P; commodities seem grossly underpriced relative to the S&P, doubly so for those expecting a deflation spiral.

Disclosure: Long gold.

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