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How strong will the dollar become before it crashes?

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Only six months ago the dilemma facing dollar analysts looked acute, with hedging the solution (see this article). Now the position looks much clearer: the dollar bottomed out around $1.50 and is now rebounding, taking commodity prices and stocks down as it goes up.

Most dramatically the gold price hit $1,226 an ounce as the dollar hit rock bottom, and has since given back $100, prompting renewed pessimism about the future of gold from the same voices that warned about gold at $300 as a ‘barbarous relic’. Oil has also dropped below $70 and could fall much further as the dollar rally continues.

Contrarian reaction

The best way to view the dollar rally is as a contrarian. The dollar rally is the contrary action to the long rally in stock and commodity prices from the March lows of this year. All good rallies eventually come to an end but for every action there is an opposite reaction.

So the dollar bottom is actually calling a major top. The dilemma for analysts has shifted from being split over the dollar outlook to pondering the extent of its recovery, and what might happen after that.

Well taking up the contrarian theme a lot will depend on how far stocks and commodities retrace their record recent rally. Will this be an orderly 20 per cent correction? Or a step down to new market lows as Bob Prechter has just said again (click here)?

My own analysis has been stated recently on this website as a part of my review for the outlook in 2010 (click here). Basically my case is that we have a monstrous bubble in global stock markets, and that argues for a bigger than average correction.

Strong dollar

Logically that ought to make a pretty sensational rally for the US dollar. The notion of $1.35 to the euro, or the $1.30 pound is perfectly possible, a prediction that would have brought calls for the straitjacket back in the summer.

However, before people living in dollar zones go rushing off to buy an extra turkey for Christmas, remember that this will only come with significant damage to asset prices, and to the highly tentative economic recovery. A strong dollar is bad for exports and lowers export earnings exchanged for dollars.

Turkeys do not generally vote for Christmas because it signals their own demise. But then the dollar rally will also contain the stuff of its own destruction.

For the bond rally that accompanies the rising dollar will also be a top to what is arguably the biggest and most dangerous bubble in the world today, US treasuries. If that bubble ever blows then the financial system will be in deep peril again.

The final crash

That is why the real contrarians like my friends at the Daily Reckoning and Dr. Marc Faber and Bob Prechter warn of an ultimate nemesis in which the US dollar crashes and burns and precious metals soar in value as the only true money in a world of paper currencies.

This final scene in the global financial crisis could be played out over a few months but far more likely a few years as the central bankers grapple with a deteriorating situation. So if you think dollar strength is a sign of economic recovery, think again and do not forget to buy some gold and silver.

(Click here for Clive Maud’s latest bullish dollar chart)

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Written by Peter Cooper

December 13, 2009 at 9:15 am

One Response

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  1. Peter, so you’re saying that while the US government (via the Treasury, the Fed, and the primary dealers) stepped in and trashed the dollar so the value of assets would go up, this time they’ll just let it all slide? Seems very unlikely. The market is so thin that any significant bid from the government would keep it propped up indefinitely. If you trade any reasonably-sized book nowadays you can feel this action every day.

    Edna R. Rider

    December 13, 2009 at 7:11 pm


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