US Dollar Bear
Notoriety
Adam Hamilton
Archives
November 15, 2004
The very foundation of contrarian investing is the premise that
the crowd is always wrong near major market turning points. Contrarian
investors carefully watch the thundering mainstream herd, noting
the dominant popular trading bias, and then consider taking the
opposite side of these trades.
The legendary Warren Buffett,
the premier contrarian of our time, summed this up beautifully
with his famous words, "Be brave when others are afraid,
and afraid when others are brave." I have been thinking
about this timeless wisdom a lot lately as I ponder the US dollar's
behavior since the elections.
Since early November, the popular
notoriety of the ongoing dollar bear has exploded. The fact that
the US dollar is in a secular bear market is certainly nothing
new. I first wrote about the coming
dollar bear in the summer of 2001 a month after the dollar's
secular top, and have been analyzing this dollar bear periodically
ever since.
Back in the early days of this
dollar bear, this whole idea was an incredibly heretical thesis.
Outside of the small band of hardcore contrarians and battle-hardened
gold investors, few believed a dollar bear was even possible
since the mighty dollar was the world's reserve currency. Surely
no foreigners would ever be so brazen as to actually sell
the dollar, right? Wall Street and the mainstream scoffed at
the mere suggestion that the dollar was rolling over into secular
bear mode.
How times have changed three
years later! Now you can't even open a financial newspaper or
watch a financial news show without hearing about the dollar
bear. My desk is literally covered with various dollar-bear articles
from Bloomberg, Reuters, and major US newspapers, all published
this week alone. Even the US Treasury was trotting out a parade
of toadies in recent days to solemnly reassure the world that
"the strong dollar policy of the United States remains unchanged."
The dollar is definitely in
a secular bear, but the popular notoriety surrounding this event
is certainly in a bull market these days. As a belligerent contrarian,
few things make me more nervous than suddenly finding myself
in a position where the mainstream starts to agree with my trades.
Buffett warned us to be brave (buy) when others are afraid (selling),
and popular fear surrounding the dollar bear is surging.
In light of this latest market
fashion of jumping on this dollar bear bandwagon, I would like
to update my dollar analysis this week. Even with the dollar
bear's immediate notoriety growing, examining the perpetual greed
and fear cycles in the dollar is always complex. Long-term and
short-term sentiment waves cascade into each other and overlap,
sometimes leading to very different outlooks over various future
time frames.
We've built two new dollar
bear charts this week, the first strategic and the second tactical
in focus. On both charts the usual US Dollar Index data is superimposed
over the Relative
Dollar, or the dollar divided by its 200-day moving average.
This rDollar indicator has been remarkably accurate in calling
major interim bottoms
in this dollar bear so far and it offers many insights into the
probability of another major bottom brewing today.
By considering the dollar in
both strategic and tactical technical terms in light of its recent
surge in popular notoriety, contrarians can gain a much better
idea of its most probable future course lying ahead over the
short, intermediate, and long terms.
As this secular trend indicates,
the dollar bear is certainly nothing new. While mainstream investors
start paying attention thanks to the exploding news coverage
of this long-underway event, contrarians and gold investors have
already been earning big profits for years by betting with
this primary trend. Indeed this dollar bear is one of the key
components undergirding the powerful Stage
One gold bull.
Interestingly, as contrarian
theory predicts, the notoriety of the dollar bear is heavily
dependent on its price. The dollar bear weighs heavily on investors'
minds when the dollar has been weak for a month or two and it
trades near its lower support line rendered above. But once the
dollar rallies back up towards resistance and has a strong month
or two, the notoriety of the dollar bear evaporates like a desert
mirage.
It is a natural human tendency
to extrapolate immediate market conditions out into infinity.
When prices rise people feel good and greedily expect farther
rises. But when prices are falling people feel bad and grow fearful
of additional drops. It takes a lot of time and effort to overcome
this psychological tyranny of the present to develop a resolutely
contrarian focus. Considering markets within their long-term
contexts is an important first step.
The secular dollar bear shown
above has had five distinct downlegs, including our current specimen.
Each major downleg lasted several months or so and dragged the
US Dollar Index down to fresh new bear-to-date lows. With the
dollar breaking 85 in recent weeks we already have a marginal
new low on this current in-progress dollar downleg. Peak to trough,
the US Dollar Index has slumped 31% bear to date.
Interestingly though, even
in light of the growing media frenzy surrounding the dollar's
latest slide, the currency doesn't look anywhere close to carving
a major interim bottom yet, let alone ending its secular bear.
There are a couple key technical reasons that a major interim
bottom isn't likely here and many fundamental reasons why this
secular dollar bear is probably not yet approaching its ultimate
end.
As this chart reveals, major
interim bottoms in the dollar, the kind that precede powerful
multi-month bear-market rallies, generally happen only when the
dollar is near its lower support line. The last two major downlegs,
labeled 3 and 4 above, both failed to bounce higher until the
dollar solidly slammed into its support. The downlegs before
that, 1 and 2, didn't travel quite as low but they still were
in the lower half of the downtrend channel approaching support
when they finally gave up their ghosts.
In contrast the dollar's fifth
major downleg today is nowhere near support. At best it is still
in the upper third of the dollar's downtrend channel, and it
probably has to grind way down into the lower quarter or so of
this downtrend in order to find strong enough support to attempt
a major bear-market rally. As long as the US Dollar Index continues
to trade high up in its downtrend near resistance like today,
odds are we aren't going to see a major interim bottom.
The Relative Dollar concurs
with this simple trending technical analysis. Note above how
the dollar's black 200dma line runs parallel with the dollar's
downtrend channel. In any secular bear market, a price gradually
marches lower by falling below its 200dma (a downleg) before
periodically retreating back up to its 200dma (a bear-market
rally). The red rDollar line precisely quantifies this key ongoing
relationship between the dollar and its trailing 200dma.
So far in this dollar bear
to date, major dollar downlegs have tended to end when the currency
was trading between 0.90x and 0.92x its 200-day moving average.
The first and fourth major downlegs both bounced when the rDollar
hit 0.905. The third ground a little lower to 0.903 before soaring
higher in a spectacular bear-market rally in mid-2003. The only
major-interim-bottom outlier was the second major downleg which
ended a bit higher at 0.922 in relative terms.
This remarkably consistent
dollar-bear performance is the primary reason why I don't consider
a major bear-market rally to be highly probable until the rDollar
trades under 0.92 or so. As this graph indicates, the lowest
the rDollar has traveled so far in our fifth major downleg today
is only 0.949 carved on November 5th. If the dollar was to turn
around here and enter major bear-market-rally mode, it would
be the highest such interim bottom in relative terms in this
entire bear to date. While a major bottom here is possible,
it is just not very probable in light of precedent.
Thus, from a pure technical
perspective the dollar ought to head lower in the intermediate
term before we see another major multi-month bear rally. The
dollar will probably head down near its lower support line as
well as slumping down under 0.92x its 200dma before today's fifth
major downleg fully runs its course. With its current 200dma,
this would yield a major interim bottom in the US Dollar Index
under 81, or at least 4% lower from here.
And if we consider fundamentals,
the long-term outlook remains bearish just like the intermediate
term. The goofy US Fed continues to create fiat dollars out of
nothing at a relentless pace. As this printing-press inflation
leads to relatively more dollars chasing relatively fewer goods,
services, and investments, the value of the dollar falls. The
Fed is also encouraging foreigners to sell dollars by keeping
US interest rates artificially low to subsidize wanton American
debtors. All of the Fed's current policies are virtually assured
to continue weakening the dollar.
Not wanting to be outdone by
the Fed, the Washington bureaucrats are also doing everything
in their power to weaken the dollar. The US government continues
to spend far more than it can steal from Americans via brutally
excessive taxation levels. The huge structural deficits Washington
insists on running are eroding America's credit and standing
in the world. In addition, Washington's newfound love of imperialism
is spawning great antipathy worldwide. Until these fundamentals
change, the dollar bear will likely remain in force.
Furthermore, in the past few
decades secular bulls and bears in the dollar have tended to
run for 5 to
7 years before maturing and reversing. Our current specimen
remains quite young by this standard, barely three years, so
duration precedent also supports the bearish fundamental outlook
on the dollar in the years ahead.
In light of these intermediate-term
technical and long-term fundamental situations facing the mighty
US dollar, it looks like the dollar shorts still have the upper
hand in probability terms. Yes, the dollar bear's notoriety in
the mainstream is growing, but apparently not enough mainstreamers
are ready to put their money where their mouths are on this so
far. The popular noise on the dollar bear ought to get a lot
louder before a major interim bottom materializes.
In early 2004, near the last
major interim low in the dollar after downleg 4, the raw level
of dollar bear notoriety greatly exceeded what we have seen in
the recent weeks. In early
January I wrote, "The relentlessly plunging US dollar
is the primary topic of some of the most widely played financial-news
stories these days. This once mighty American currency is rapidly
falling from international grace, and even conventional media
outlets are focusing more and more on the enormous implications
of the down-spiraling dollar. ... With the dollar's plunge now
headline financial and even general news across the globe, one
of the most popular bets around these days is to short the US
dollar."
We haven't yet reached the
everyone-shorting-the-dollar stage this time around, but odds
are we will before the fifth major interim bottom of this secular
dollar bear is carved. When the growing media hype surrounding
the dollar bear is eventually backed by a massive surge in dollar-short
plays by Wall Street and the mainstreamers, then contrarians
will really have to take note. For now though, this fifth downleg
does not appear to be in jeopardy of spiraling out of hand.
With the probable intermediate
and long-term scenarios addressed, that leaves the short-term.
Our next chart encompasses just the past year or so, the small
blue-shaded area in the lower right corner of the graph above.
Interestingly, while the dollar looks bearish in the months and
years ahead, the outlook over the next few weeks actually looks
bullish.
Like pretty much everything
else having to do with the markets, dollar sentiment is fractal
in nature. In addition to episodes of popular bullishness and
bearishness at the major interim tops and bottoms on a strategic
scale, there are also miniature sentiment waves that cascade
through the dollar over the short term. I suspect the current
notoriety of this dollar bear is a product of a short-term sentiment
wave rather than a long-term one.
In this tactical chart we can
see the end of the fourth major dollar downleg and the beginning
of the fifth. Just as general dollar sentiment was rotten and
everyone was shorting in January (except us contrarians), dollar
sentiment was positively glowing at the currency's latest major
interim top in May. I was watching this top very closely and
went long
gold stocks again after their early 2004 correction so I
paid careful attention to what was said about the dollar.
After that May top, big Wall
Street brokerages were predicting additional serious moves higher
in the US dollar. I remember reading a couple reports calling
for a target level of 100 in the US Dollar Index before 2004
ended. This dollar-bullish noise grew so intense and loud that
even some analysts who usually traffic in contrarian circles
were sucked in. To their credit the "contrarians" weren't
as bullish as Wall Street, but I saved contrarian newsletter
reports from this summer calling for 95 to 96 in the dollar index
by autumn.
Dollar bullishness also exploded
again in late August as the dollar threatened to break out from
both its short-term and long-term resistance lines. If you compare
this tactical graph to the earlier strategic one, you will note
that the dollar hugged both key resistance levels for a couple
months. This was a particularly rough time for gold investors,
as dollar strength usually translates into gold weakness. If
I had an ounce of gold for every e-mail I received on this between
late July and early October, I could start my own central bank.
The point of all these observations
is to illustrate that the noisy majority is always wrong
near market turning points. Dollar bears came out of the
woodwork last January as bearish media coverage exploded, but
they were wrong. Only contrarians predicted
a major bear-market rally in the dollar. Similarly, in May and
later last summer, dollar bulls multiplied along with
bullish media coverage. Only contrarians predicted
that the fifth major dollar downleg already underway would accelerate
into autumn.
By the time any market event
becomes mature enough or prominent enough to dominate the major
news outlets, odds are that the vast majority of that move is
past. If you buy when others are brave and sell
when others are afraid like a mainstreamer, perverting Mr. Buffett's
brilliant advice, sooner or later you are going to lose all your
trading capital in the markets. If you want to consistently win,
you have to force yourself to adapt a contrary focus to
mainstream investing popularity.
And this thought brings us
to today. The intermediate-term and long-term outlook on the
dollar remains bearish, but short term a bounce is certainly
possible. By a bounce I don't mean a massive multi-month bear
market rally like the first half of 2004, but a sharp move higher
over a couple of weeks or so. Two previous bounces are
labeled above, in June and July, which each carried the dollar
higher for a short spell.
Technical bounces are totally
normal during major downlegs, they help bleed off temporarily
excessive fear and rebalance sentiment. Today's soaring media
coverage and the resulting growing notoriety of the dollar's
weakness is both a result of growing fear and a catalyst for
even more fear. Unless the dollar bounces briefly, fear could
get out of hand. Bounces solve this sentiment problem.
These technical bounces generally
occur when the dollar hits its tactical support line, just as
it did in June and July before the previous two bounces. As you
can see in this chart, the US Dollar Index just slammed
into this same support line again for a third time in early November,
and a minor bounce may already be in progress.
If this fairly-high-probability
bounce indeed materializes in the coming weeks, it could carry
the dollar back up as high as 86+, up to the same upper resistance
line at which the currency lingered last summer. But, even if
the bounce does run all the way back up through the dollar's
tactical downtrend channel, odds are it will be short-lived.
With strongly bearish intermediate and long-term outlooks, any
dollar strength on a minor technical bounce will probably be
fleeting at best.
The bottom line is the dollar
bear's notoriety is growing, which naturally causes concern among
contrarians. A contrarian wants to buy when others are afraid
and sell when others are brave, so contrarians short the dollar
today are wary that the mainstream is growing too fearful of
the falling dollar. But, thankfully for contrarians, the technicals
and fundamentals only seem to support a short-term dollar bounce
at best, not a major bear-market rally and certainly not the
end of the dollar's secular bear.
If you are interested in trading
this potential dollar bounce, please consider subscribing
to our acclaimed Zeal
Intelligence monthly newsletter. In the current November
issue I discuss how we are planning on playing a dollar bounce
in terms of the primary beneficiaries of dollar weakness, gold
stocks and gold-stock options.
While such a minor dollar bounce
would probably hurt these speculations short-term, it would create
some excellent buying opportunities if the dollar does head up
to its own resistance for a short time. We are currently screening
various gold-stock options as well as junior gold miners for
potential purchase if the dollar does indeed challenge its resistance
again before its downleg resumes in earnest. It would create
the first good buying opportunity for leveraged gold plays since
last summer.
Our subscribers also have exclusive
access to a new subscriber-only charts section on our website,
which among dozens of other charts includes a high-resolution
Relative Dollar chart updated at least weekly so you can monitor
the ongoing progress of this major dollar downleg. This is especially
important for gold investors since gold's next major correction
will probably commence the moment this fifth major dollar downleg
ends.
The dollar bear's notoriety
is certainly growing, but so far the popular fear doesn't look
great enough to do anything besides spawn a minor dollar bounce
at best. Contrarian investors and speculators directly or indirectly
short the dollar probably have nothing to fear in the intermediate
and long-term time horizons.
November 12, 2004
Adam Hamilton, CPA
email:
zelotes@zealllc.com
Archives
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