Top trader: What to do about the falling dollar
From Ben Morris, Editor, DailyWealth Trader:
The U.S. dollar has gotten smashed…
It’s down 7% since the start of the year, including a 0.5% drop yesterday.
That’s a big move for a major currency. It affects global economics and our investments. So today, we’ll look at the forces acting on the dollar and what it means for investors.
Last week, European Central Bank (ECB) President Mario Draghi said that the European economy is improving…
Draghi is the same person who famously pledged five years ago to do “whatever it takes to preserve the euro.” With countries around the eurozone struggling to pay their bills, the ECB had to print hundreds of billions of euros to bail them out.
In June 2014, the ECB dropped its short-term interest rates into negative territory as an effort to stimulate lending and spending. Then in January 2015, Draghi announced a massive, €1 trillion bond-buying program to further stimulate the European economy. The ECB later added an extra €1.3 trillion to that initial amount… and extended the program through the end of this year.
Now, with Draghi starting to acknowledge improvement in Europe, the markets are worried that the ECB will begin to “taper” – reduce and eventually stop its stimulus.
Yes, I know this is a roundabout way of talking about the dollar. But this context is important…
The ECB has followed the same playbook that the U.S. central bank, the Federal Reserve (the “Fed”), laid out years ago. When the U.S. faced disaster during the financial crisis, the Fed printed trillions of dollars to bail out failing companies and then to stimulate the U.S. economy. It cut interest rates to nearly 0%.
As we often say in DWT, a currency is like the share price of a country. When the Fed finally began tapering in December 2013, it was a sign that the U.S. economy was improving. Not only that… With interest rate hikes on the horizon, the dollar was a more attractive place to hold cash. (People like earning more interest.)
As you can see in the chart below, not long after the Fed began tapering, the dollar soared…
The U.S. Dollar Index in the chart above shows the dollar’s value relative to a basket of foreign currencies. The euro makes up more than half of that basket. So when the dollar is rising, the euro is almost certainly falling… and vice versa.
The euro recently jumped to its highest level of the past year. As you can see in the chart below, the action in the euro is like a reflection of the action in the dollar…
In other words, what is bullish for the euro is bearish for the dollar. Draghi’s comments were both…
We noted on March 24 that the dollar was on the verge of breaking down and that a “head and shoulders” chart pattern was setting up. This pattern usually shows that a move has run its course… And it often marks a turning point. (You’ll find information about this pattern at the link above.)
As you can see in the chart below, the dollar pushed through its “neckline” and continued lower…
Chart patterns are rarely perfect. But this head and shoulders was close. The dollar bounced after breaking down… But it then headed lower. It has been in a downtrend since our issue.
What does this mean for our trading? As I explained in March…
A breakdown in the dollar wouldn’t be all bad. A weaker dollar means U.S. goods and services are more affordable to foreigners. So it can support U.S.-based, international businesses. That’s good for our “trading for income” strategy… which we often use with global blue-chip businesses.
A falling dollar supports hard-asset prices, too… like gold. In the U.S., gold is priced in U.S. dollars. So when the dollar falls, it takes more of them to buy an ounce. This (in isolation) translates into a rising gold price. Since the end of 2016, the U.S. dollar is down 6% and gold is up 8%.
That said, gold hasn’t risen as much as lots of folks expected while the dollar has fallen. We have to remember that the dollar influences gold… But it’s not the only influence. We’ll continue to monitor gold itself for more clues on where it is heading.
With Europe and the euro starting to improve, the dollar will likely either trade sideways or fall from here. Things can change, of course. But we’re positioned well…
We hold lots of U.S. stocks (including a few gold stocks). We’re trading for income whenever we turn up a great put-selling opportunity. We’re holding foreign currencies which should benefit as the dollar falls. And we’re making money on 67% of our open positions.
The dollar’s downtrend is worth keeping an eye on. But it’s nothing to worry about. Our trading plan in DWT is to do more of what we’re doing. It’s working.
P.S. We haven’t seen much action in the commodities, yet. But with more inflation expected in Europe and around the world, another big run may not be far off.
I’m looking forward to learning more about the current state of the natural resource world – along with many of the best ways to profit in it – next month, at the Sprott Natural Resource Symposium in Vancouver, Canada.
Last year was my first time attending the event. It was extremely valuable. I’ll share my top takeaways with you here in DWT. But if you want to get the details of most of the top companies that natural resource legend Rick Rule is investing in, you need to go for yourself. Learn how to get your tickets right here.