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December 10, 2004

Dollar Daze!
by David Chapman

It is amazing what a headline can do. The Economist headline this week was "The disappearing dollar". It seemed no sooner were the words out of their mouth then the dollar staged a sudden remarkable rally. If we look around we would have noted that stories on the demise of the US Dollar seemed to be everywhere. A sampling even of stories on saw "The dollar stares into the abyss - Maund", "US Dollar Peso crisis underway - Captain Hook", "The Weakback Greenback - Gotthelf" we could go on. We did see one entitled "Why the US$ is likely to rise - Saville" which was counter to the overwhelming Dollar bears. But it was the stories in the mainstream press that were an even bigger clue to a possible contrarian reversal. And to admit mea culpa, even we had contributed negative stories on the US$ over the past number of weeks.

As a recent issue of "The Elliott Wave - Financial Forecast" noted negative Dollar stories it seems were every where "headlines from papers around the world convey the depth of the global disgust". And so they should. In a soft criticism The Economist said, "America has habits that are inappropriate". Those bad habits are of course "rampant government borrowing, furious consumer spending and a current account deficit big enough to have bankrupted any other country some time ago".

Even high profile US financial figures such as former Clinton Treasury Secretary Robert Rubin, Fed Chairman Alan Greenspan, former Clinton Labour Secretary Robert Reich, Treasury Secretary John Snow were if they were not actually talking the Dollar down they were at least suggestive of the fact that the US Dollar should go lower. And our two favourites Chief Economist of Morgan Stanley Stephen Roach who has said that America has a 1 in 10 chance of avoiding an economic Armageddon and Li Ruogu, Deputy Governor of the People's Bank of China (China central bank) who admonished Washington not to blame outsiders for its disorderly accounts, but instead put its own house in order.

Elsewhere we have seen numerous stories in the Canadian press besides the ones about the falling US$ but also about the sharply rising Canadian Dollar. It was predicting gloom and doom for Canada's strong export sector where over 80% of Canada's trade goes south of the border versus under 20% of US trade going north of the border. Stories abounded of Canadian exporters seeing their exports slow or in some cases plants closing in Canada and reopening in the US. Seems that numerous exporters bought into the propaganda when the Canadian Dollar was trading at 63 cents to the US$ that it was going to fall to 50 cents or even lower. Cries have been rampant for the government to do something to stop the rising the Canadian Dollar. We are always reminded that no one ever devalued their way to prosperity. So what is wrong with a rising currency?

Recently the Canadian dollar hit the highest level since early 1992 at roughly 85 cents. Since bottoming in January 2002 under 62 cents the Canadian Dollar has rallied an impressive 37% to its recent highs. The US Dollar has fallen 33% since topping in 2001. We had targeted recently down to 80.50 so the lows at 80.94 were close. Since then the US$ has rallied a mere 2% or so to around 82.75. But the reaction in the market has been nothing short of astounding almost as if the US$ were to suddenly rush back to 120. The Canadian dollar fell almost 4% and even more spectacularly Gold fell over $20 or almost 5% and Silver fell like it had been shot out of the sky falling almost $1.60 or 19% in a matter of days. Gold stocks as measured by the Gold Bugs Index (HUI) fell 16% to its lows before rebounding.

Incredible that a 2% rally in the US$ carried out undoubtedly by some intervention by the Central Banks and short covering caused near panic in gold, silver and gold stocks. And we thought all the stories and focus was on the US$ not on gold, silver and gold stocks. So was everyone suddenly dumping all of their gold and silver? Not likely. Activity in the derivatives market was furious so the drop was caused almost exclusively by paper trading.

Admittedly while the US$ was falling 33% since 2001 Gold had increased roughly $200 or about 78% and Silver had doubled while Gold stocks (HUI) were up almost 600% so maybe it wasn't such an overreaction after all. And numerous pundits will point out that while Gold had made new highs in its recent up move Gold Stocks (HUI and XAU) had not made new highs. Nor for that matter did silver. Still the sudden downdraft probably came as a shock to numerous gold bugs. But just as the US$ was seeing record bearishness with record low sentiment and the large speculators (hedge funds?) were at record net shorts Gold and silver were the opposite with very high bullish sentiment and the large speculators COT was recording very high levels of bullishness. So maybe it was just an adjustment that was overdue.

So now if the contrarians are right the US$ should embark on a good rally while gold, silver and gold stocks take it on the chin for a while. And it is not just gold, silver and gold stocks that will take it on the chin. We note that that very high bullish sentiment is present in the broader stock market, commodities, oil and real estate as well. It is also noted that junk bonds are on pace for record new issues so we could add junk bonds to the very bullish sentiment.

So does that mean the US dollar has bottomed? Well maybe not quite yet. There is an argument that the US$ can bottom here as all other asset classes fall including stocks, bonds, precious metals, real estate, and oils. As they fall there would also be a debt collapse and as a result Dollars would become more valuable putting upward pressure on the currency. It is possible but the real risk here remains a series of competitive devaluations around the world similar to what we saw in the Asian currency crisis in 1997. Here the problem is the Chinese Yuan, which remains tied to the US$. As the US$ falls so does the Yuan. And that makes China's major trading partners nervous as their currencies rise against the Yuan. The real currency crisis could come if they suddenly lurched into a series of currency devaluations in order to protect their position.

Gold then in our opinion as the only store of real value should under those conditions soar. After all paper currencies are backed by nothing. And the US$ as the world's reserve currency is being questioned as to how a devaluing currency can remain the world's pre-eminent currency. The world has seen numerous reserve currencies over the centuries including the Roman Denari, the Byzantine Solidus, the Dutch Guilder and the British Pound. All eventually fell as the world's reserve currency so there is in that respect nothing sacred about the US$ as well. There have been calls for a new Bretton Woods to solve the world's precarious financial situation including inside the US led by Economist Lyndon LaRouche.

At best the US$ could rally back to the break down line up at 85.50-86.00. This could drop Gold to key longer term support near $420. But remember this is our worst case. There is also good support for gold in here just above the former highs near $432. So a bounce is due from these levels. The strength of the rebound will determine whether the lower figure of $420 is feasible or not. Silver as been quite beat up but does have significant support at $6.50-$6.70 so we may have seen the worst of the silver drop. Clearly with serious pressure on world silver supplies the drop was not justified from any fundamental standpoint. The pattern playing out while scary may just be part of the correction that began earlier in the year. Clearly if we were to break down under $6.50 we could fall to longer term trend line support near $6.20.

This purge in the metals and the rebound in the US$ is a temporary phenomena. The long term fundamentals for the US$ remain very weak until the US takes the course of correcting the huge a growing imbalances. No matter how these imbalances are resolved the results will be painful for both the world and the especially the US. Don't be fooled by Dollar Daze.

DavidChapman.com
Technical Scoop

Charts and technical commentary by:
David Chapman of Union Securities Ltd.,
69 Yonge Street, Suite 600,
Toronto, Ontario, M5E 1K3
(416) 604-0533
(416) 604-0557 (fax)
1-888-298-7405 (toll free)

David Chapman is a director of Bullion Management Services the manager of the Millennium BullionFund www.bmsinc.ca

Note: The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete.

The information in this report is drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does Union Securities Ltd. assume any responsibility or liability. Estimates and projections contained herein are Union's own or obtained from our consultants. This report is not to be construed as an offer to sell or the solicitation of an offer to buy any securities and is intended for distribution only in those jurisdictions where Union Securities Ltd. is registered as an advisor or a dealer in securities. This research material is approved by Union Securities (International) Ltd. which is authorized and regulated by the Financial Services Authority for the conduct of investment business in the U.K. The investments or investment services, which are the subject of this research material are not available for private customers as defined by the Financial Services Authority. Union Securities Ltd. is a controlling shareholder of Union Securities (International) Ltd. and the latter acts as an introducing broker to the former. This report is not intended for, nor should it be distributed to, any persons residing in the USA. The inventories of Union Securities Ltd., Union Securities (International) Ltd. their affiliated companies and the holdings of their respective directors and officers and companies with which they are associated have, or may have, a position or holding in, or may affect transactions in the investments concerned, or related investments. Union Securities Ltd. is a member of the Canadian Investment Protection Fund and the Investment Dealers Association of Canada. Union Securities (International) Ltd. is authorized and regulated by the Financial Services Authority of the U.K.

Copyright © 2002-2008 David Chapman

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