Federal Reserve Chairman Ben Bernanke in a press conference last week made comments about the U.S. Dollar including that �it fluctuates.� The only direction it has fluctuated since he has been in charge at the Fed is lower. If lower and fluctuation are synonyms, I wish my weight would fluctuate!
If the Fed continues on the same path it is possible that the dollar could go through a real currency crisis. The potential for such an event is intensified by the fact that Asia and Europe are raising interest rates due to inflationary pressures. Time will tell but gold and silver remain strong. However I would not fall in love with either commodity, or any commodity for that matter. Whether we have a currency crisis or not, there should be no surprise in this nasty sell off in silver.
I agree with many market prognosticators in that we are in a commodity bubble. The weekly chart of silver futures below illustrates just how parabolic the move has been:
At some point the dollar will bottom, and when it does a significant rally will take shape. When the dollar rallies it has the potential to be sharp and fast. Silver would be hit hardest as the chart above shows the parabolic move higher that has transpired over the past few months. The timing of the dollar�s bottom is difficult to quantify, and picking bottoms is a fool�s game. Nevertheless, the commodity charts will tell us when it�s time for the rally to unfold, but for right now prices will likely continue higher for commodities and equities.
Longer-term, precious metals investors might be able to withstand the impending sell off. The other side of that sell off will likely see gold and silver work higher still. Longer term gold and silver will likely perform well, but traders must be aware that a sharp pullback is not only likely, but would be considered healthy by many market participants. The Dollar Index weekly chart illustrates the sharp sell off in the dollar the past few months.
The longer term SPX chart may be a guide as to when the dollar will begin to bottom. The S&P Index Options (CBOE: SPX) weekly chart shown below illustrates the long term ascending channel that the S&P 500 has been trading in for some time.
My educated guess as to when the dollar will begin to bottom will likely coincide with a test of the ascending trend line. In previous articles, I opined that I thought we would see the S&P 500 rally. We are in that process now. My guess is that about the time the S&P 500 tests the rising channel we will see the dollar begin to bottom. The short opportunities that will be presented from a risk/reward perspective could be outstanding.
Cycles typically line up, particularly when one particular asset, in this case the dollar, are driving markets in one particular direction for a long period of time.
Typically business cycles end when there are rallies in commodities and commodity-based stocks such as Exxon (NYSE:XOM) and Barrick Gold (NYSE: ABX). We are in that stage of the business cycle right now, and typically when that stage has been reached it is indicative that the economy is starting to overheat.
Cyclicality in financial markets has been discussed for years, but often technical analysis will align with the business cycle. While I may not be exactly right as to the timing, it certainly gives a solid framework for risk-based decisions going forward.
Conclusion
I believe that the actions taken by the Fed for the past two-three years are going to result in additional selling pressure for the dollar. That will propel commodity and equity futures prices higher than what many will expect.
While the sell off may occur within the confines of a short- to-intermediate-term time frame, the dollar will eventually bottom and a nasty sell-off in commodities and stocks will transpire. Then the next leg of the secular bear market will begin. The business cycle and the technicals are aligned at this point; the question is really how long it is going to take to get there.
The end game will likely result in the Fed looking foolish while the American people and the global economy suffers. The possibility that the Fed is forced to raise interest rates to slow down inflation at the same time the dollar bottoms is a recipe for an economic disaster.
Slowing economic conditions based on higher oil prices and inflationary pressures paired with higher interest rates will result in another recession fueled by the Fed�s Keynes-based economic models and decision making. Bernanke was right about one thing — the Fed uses educated guesses based on its models when setting monetary policy. I posit to readers, what happens if the Fed chairman and governors� price models and educated guesses are completely false?
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