We believe that the US Dollar is in the early stages of a multi-year bull market…BUT…short term…we think that the rally has run too far too fast and a correction is due. We do NOT recommend taking outright short Dollar positions in anticipation of this correction…but…given the sharp jump in FX option volatility the last couple of months…we think writing short-dated OTM puts against short currency positions would be a good idea. A correction in the Dollar rally would see gold and commodities bounce.

The US Dollar Index traded at new 4 year highs last week…up ~11% since July…it is now only ~1.5% away from hitting 8 year highs. CAD hit a 5 year low last week (8725)…it was at par just 18 months ago. The Yen hit a 7 year low last week…down ~32% since Abe pushed the BOJ to start devaluing the Yen (2012) as part of their plan to end 20+ years of deflation in Japan…the Yen is down ~8.5% in the last 3 weeks.

The Russian Ruble has collapsed despite efforts by the Russian Central Bank to “slow” the decline. It traded at lifetime lows last week…down ~40% since June…down 60% since February 2013. The sharp fall in oil prices and sanctions pressured the currency…but capital flight has hammered the Ruble.

WTI Crude hit 5 year lows last week…down ~30% since June…Gold hit 4½ year lows…down ~30% from its 2011 ATH…the major commodity indices hit 4 year lows…down ~30% from their 2011 ATH.  

We’ve traded currencies for 40 years and believe that they “trend” more than other markets (who remembers leads and lags?)…that the trends go WAY further than seems to make any sense…and then reverse in “Vee” shaped turns. This tendency for currencies to go WAY further than seems to make any sense (plus our long-term bullish Dollar view) is the reason we do NOT recommend outright short Dollar positions. BUT…we note the HUGE ($45B) long dollar position in the futures market and the “beating” dollar-priced commodities have taken…and we “sense” a correction. Adding to our “sense” of a correction is a weekend report (Nov 9) from our long-time friend and excellent technical analyst, Ross Clark, warning of an “overextended” dollar…and a likely bounce in Gold.

Why has the US Dollar rallied against nearly all other currencies?

Market Psychology senses that it’s a deflationary world…especially outside America…despite all the Central Bank efforts…with the bigger risk being that the world becomes even more deflationary. Capital has become “less willing” to embrace risk and flows away from the “periphery” and back to the “center” seeking safety and opportunity. Capital flows beget even more capital flows with the risk that a trend becomes a torrent…and then a rout…witness the collapse of the Russian Ruble.

Capital flows driven by changing Market Psychology can be far bigger than trade flows…capital can continue flowing to America even if the USA runs huge trade deficits…even if a rising Dollar makes American products and services uncompetitive in world markets…we note that ~46% of the total sales of S+P 500 companies are generated overseas…a strong Dollar “should” make it tougher for these companies to generate overseas sales…but that in and of itself won’t reverse a Dollar rally driven by investment flows.

Divergent Central Bank policies favor the Dollar. Market Psychology prefers an America that is “less socialist”than the Rest of The World. Rising domestic energy production (carbon based and otherwise) favors the Dollar.The Republican gains in the recent mid-term elections favor the Dollar…In 1995 the Republicans took the House and the Senate…the Dollar rallied ~50% over the next 5 years…while the S+P 500 tripled!  

The ebb and flow of market cycles also favors the Dollar. It was very “out of favor” after its 1995 – 2002 up-cycle and fell for the next 6 years while commodities boomed. It made an All Time Low in 2008 before the credit bubble burst…and rallied sharply for several months as stocks, commodities and interest rates fell. It chopped broadly sideways for 3 years but (we think) began a new multi-year up cycle in 2011 in sync with the end of the commodity market bull cycle.

Japan:

Mr. Kuroda…the head of the BOJ…has told the world that he is determined to break the deflationary mindset of the Japanese people…using extraordinary monetary policies. We have no doubt that he is determined…and he may succeed…but as we noted last week it feels like we just stepped into a Brave New World and the stakes are WAY bigger than they were before. Back in 1979 Paul Volker was determined to break the inflationary mindset of the American people…using extraordinary monetary policies…and he succeeded…ultimately igniting a 30+ year bull market in bonds…you have to wonder if there will be a 30+ year bull market somewhere if Mr. Kuroda succeeds….

Could it be stocks?

The Japanese Government Pension Fund announced that they will make a major shift in their portfolio holdings…going from 60% bonds/25% stocks to 35% bonds/50% stocks. Their actions will “green light” other major pension funds in Japan to make similar shifts from bonds to stocks. This is part of a global trend of pension funds “re-balancing” their portfolio mix. They have actuarial liabilities that they can’t achieve with bonds…so…all over the world pension funds are (and will be) switching from bonds to stocks. This will “favor” stocks.