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October 21, 2004

The Dollar - Poison for the Dow?
by Alex Wallenwein

After anticipating the coming Dow-Gold Crossover in the last essay, let's take a look at the Dow-Dollar crossover that has already happened in mid-2003. There are a number of revealing insights that can be gained from this chart:

1. Since February 2002, whenever the Dow rose, the dollar fell;
2. Whenever the dollar rose, the Dow fell;
3. Sometimes the Dow and dollar fell together;
4. The Dow and dollar (almost) never rose together (except for a very brief three-week-or-so period during April/May of 2004).

On this chart, due to the way it is drawn, the visual crossover occurred in May of 2003, but the actual parting of ways between the dollar and its progeny, the Dow, occurred about a month earlier, in early April 2003.

However that may be, the world hasn't really been the same ever since.

We all can remember only too well the time during the latter nineties, when gold was bashed big-time in order to not let on what would otherwise have been apparent: that the dollar was way overprinted and was in danger of collapsing even back then. Instead, it was kept super-buoyant by suppressing its only real alternative - gold. The reason? To keep attracting foreign investment funds to US assets and thus prolong the party everyone was reveling in.. If the dollar appreciated, all other US holdings by foreigners would appreciate right along with it and keep them happy. The US needed that to fund its then already voracious current account-deficit.

Just take a look how big it's gotten since then: Of all US assets, treasuries and the Dow/Nasdaq were obviously the biggest beneficiaries. The rising dollar made these assets even more attractive than the already maniacal Dow curve had done. But now, what have we got?

As noted before in other essays, we live in crazy times these days. It's an upside-down world out there. Traditional correlations of economic indicators are breaking down, and new, far more shaky ones arise. Here are two major examples:

1. Gold, the primordial inflation hedge, now gets a boost when inflation is low rather than high. Why? Because with low inflation, the Fed doesn't need to raise interest rates as rapidly, which is dollar-negative on balance, and therefore gold-positive. Another reason for this is that after two decades of incessant misreporting and spinning by the financial press and other nes commentators and reporters, gold is now regarded as somewhat of a "fringe investment". The traditional flight-from-paper effect of rising price-inflation will this time come later than it used to - but it will come, believe me!

2. Interest rates are the Fed's primary tool for "guiding" the business cycle. In the past, when the Fed lowered rates by a significant amount, a credit-fed boom invariably followed. But even though they were pushed way down to historic lows and kept there for over a year, this time the resulting cycle of borrowing, spending, hiring, and inventory building by businesses has kicked in way too late and is threatening to peter out far too early to ignite the kind of boom that policy makers had hoped for.

Instead, this time around, rather than spurring additional investment and production by businesses, the low rates only helped the economy by sucking already strapped consumers even deeper into the quicksand of the mortgage re-fi swamp, and thus made them think they have more "spending cash."

3. Finally, it now appears that the dollar, that symbol of American economic might, must drop to insignificance in order to allow US businesses at least a semblance of competitiveness with their foreign counterparts - counterparts that operate in countries who have nothing better to do than print prodigious amounts of paper-money to buy dollars and treasuries so their exports can remain artificially competitive. No wonder that Bush officials have repeatedly harangued their Chinese-commie counterparts to please, please, please! let the Yuan rise so the upward pressure could be taken off the dollar.

Decades-low short and long-term interest rates, held there for a full year, have failed to spur the kind of economic miracle recovery policymakers where shooting for. It is notable that last year's Dow "recovery" appeared to coincide with a continued dollar-drop dating all the way back to the USNDX' January 2002 high near 122.

As the chart above shows, during the period from January 2002 to the end of June 2002 the dollar and Dow dropped together like a co-dependent junkie couple. Then the dollar began to stabilize, which threw the Dow into violent convulsions until October 2002, when the dollar resumed its downtrend.

That resumption of the downtrend appeared to have "saved" the Dow and helped it to stabilize. Later, in March 2003, the Dow finally bottomed again and began its rather spectacular uptrend that lasted precisely until February of 2004, when the dollar bottomed and reversed course, which was the signal for a Dow reversal and protracted weakness (see the narrow downtrend channel continuing to this day).

The problem is that the post-May 2004 resumption of the dollar's downtrend did nothing to revive the Dow from its recent malaise.

Extremely instructive here are the two rectangles outlined in red. The first one shows that the Dow actually was mainly flat while the dollar rose from June to September 2003, during a time that superficially looks like the two were rising together. The other interesting part is that the dollar's bottom and the Dow's top during February 2004 exactly coincided. The right border of the second rectangle shows the 2004 dollar top, from which it fell into a tight but declining trading wedge, the lower line of which it has convincingly breached today, October 20, 2004.

Forebodingly - although not necessarily so significantly, the Dow has not benefitted from today's dollar drop. Admittedly, one day does not an established trend make, to be sure. But the current Dow-down/dollar-down trend has been in place since May this year - and that despite the "powers" all-out attempt to trash gold during that very month! That oughta give you somethin' to think about.

It is apparently felt among US economic policy makers that only a vastly accelerated dollar-drop can revive the stagnating and declining Dow. The uncomfortable fact that gold will unavoidably trend upwards together with the Dow as the dollar falls is apparently within the power mongers' pain threshold - a necessary "price" to pay for continued Dow-health.

Let's face it: the Dow is the US new economy's most enduring symbol of phony strength. The whole world looks at the Dow, not least among which are US investors, consumers - and voters. As long as they see the Dow above or at least near the 10,000 mark, all is well in investor land. An already crushed and anaemically languishing Nasdaq or S&P 500 can be tolerated, and no one ever looks at the NYSE anymore, at any rate. But the mighty Dow, now that's another story altogether.

That brings us back to the question raised in the Gold-Dow Crossover article: if a continued dollar-drop results in no appreciable Dow-recovery this time, the concomitant rise in gold prices MUST be stopped at all cost, lest the Dow descend into the pits of hell! The only question remaining is: will they be able to pull it off yet again, one more time? Here is some evidence that they are working on it already. This Bloomberg.com article talks about how "vulnerable" the gold market is right now due to its "overbought" condition - but one day later the dollar rammed through major support at $1.25 to the euro, and gold rose above $420.00.

Nevertheless, even if the opportunity comes and if they take it, pushing a normal gold correction farther and deeper than it ordinarily would go on its own, will they be able to make it stick for more than a few weeks this time?

Their dilemma is readily apparent. "Es liegt auf der Hand," as the Germans say (transl.: it lies in the palm of your hand, ready to be seen). The faster and lower they let the dollar fall, the more powerfully gold will want to rise, and the harder it will be for them to restrain it.

So, my hunch is: they will not be able to pull it off again like they did in May this year. Not this time. The reason?

Oil - and Rising Interest Rates

A 70% year-to-date price rise in oil makes everything more expensive. The Fed guys can crow all they want that this oil price explosion has had "no significant impact" on general price levels. Maybe not in their books. Not right now - but very soon they will have to show it even in their own cooked books.

Rising oil means rising production costs and rising transportation costs. It also means lower spending as disposable earnings shrink. Rising rates mean less consumer borrowing and spending, and even less business spending. All of that weighs heavily on corporate profit margins which are the only basis for sustained stock appreciation. The Plunge Protection team can conspire and buy stock futures all year long - they cannot plug the cracking dam anymore.

Will oil prices recede again? Sure they will - but from where? And when? And how far, before they resume their inexorable uptrend that is dictated by the "Hubbard's Peak" dilemma? And, since rising oil means rising price-inflation, rising gold (and silver) prices are surely riding on its back.

Hi-ho, Silver!

Hi-ho, Gold!

Got gold?

Alex Wallenwein
Editor, Publisher
The Euro vs Dollar Monitor

Just like driving your car, investing only makes sense if you can see where you are going. The Euro vs Dollar Monitor is your golden windshield wiper that removes the media's greasy film of financial misinformation from your investment outlook. Don't drive your investment vehicle without it!

Copyright © 2003-2008 Alex Wallenwein

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