-- Posted Monday, 27 October 2008 | Digg This Article
| Source: GoldSeek.com
By: Peter J. Cooper
A year ago I wrote about how a stock market crash would likely be accompanied by a US dollar rally, and several eminent commentators gave me a good deal of stick, and one sent me a series of charts showing that it was highly unlikely.
This criticism rather put me off the subject, though I stayed long in US dollar assets personally which has been a nice counter to the less than heroic performance of my precious metals portfolio recently (albeit I remain confident of a rally for reasons which will become obvious below). However, the US dollar has indeed shown immense strength during the October crash and I have been glad that I kept my money were my mouth had been.
Perhaps a little emboldened - though far from hubristic I hope - by this correct prediction, it is time to look at when the dollar rally might end. Nothing lasts forever, especially in markets where the VIX volatility indicator is at an all time high - indeed that means we should expect the unexpected.
Marc Faber
My friend Dr Marc Faber has delivered a remarkable reassessment of the German Weimar Republic in the latest edition of ‘The Gloom, Boom & Doom Report’ (subscribe today, it is the best financial newsletter in publication). He explains how in the early 1920s the German middle classes were ruined by currency devaluation which caught them totally unaware after a period of asset price deflation.
Let us not forget that the modern US economy is very much like the Weimar Republic - some might add a Banana Republic - with its huge internal and external debts, now compounded by a strong currency. It is the current equity sell-off - dramatic and sudden as it continues to be - that is causing this flight to the dollar.
Actually it is automatic - if you sell a dollar-denominated asset you get dollars in return, therefore increasing the demand for dollars and raising its value against other currencies.
What then might precipitate a sudden move in the reverse direction? I think the most obvious candidate has to be a rally in equities. This is not as stupid as it sounds. All big sell-offs are followed by a relief rally - which is just some people who sold out of stocks deciding to buy them back at the new, lower prices.
Equity rally
Now when they do this there will be a reverse move: out of the dollar and into equities, or more particularly out of bonds and into equities. This could well crash an already very fragile bond market and set off a chain reaction of financial collapses that would hit the US dollar very badly.
Of course, this is a pessimistic scenario. But is it more likely than an optimistic scenario: a new president confidently takes the reigns of office, bails out here, stimulates there, avoids a serious recession, rescues the housing market and keeps the dollar and financial markets steady?
President Obama will have a new team, and they do not take office for a vital couple of months while the financial crisis festers further. Any economist will tell you this is dangerous. Markets hate uncertainty and tend to vote with a move to the exit. Perhaps the next exit door has the words ‘bonds’ and ‘US dollar’ written on it.
Nonetheless, the sell-off in global equities still seems to have some way to run and the US dollar should hold firm until it ends. But when the selling stops then it might be wise to switch into any currency less exposed to a recession than the US dollar, and of course into precious metals as an alternative currency with a fixed supply and no third-party risk.
Peter J. Cooper
http://arabianmoney.net/
-- Posted Monday, 27 October 2008 | Digg This Article | Source: GoldSeek.com
