How to invest around a U.S. dollar rally

Posted by David Rosenberg - Gluskin Sheff

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This massive reduction in risk appetite has triggered a flight to safety and liquidity, which in turn means the USD, has been a major beneficiary from all this uncertainty. On a trade-weighed basis, the greenback has firmed to seven month highs, and this also has implications for how to be positioned in other asset classes.

For example, this is the primary reason why gold has succumbed — selling by  hedge funds closing out long positions and outflows in ETFs as well; though the yellow metal has hung in well relative to other commodities and is still range- trading in most other currencies.

Copper, meanwhile, sank 6.5% last week and on heavy trading volumes and crude oil broke below its 200-day moving average.  We seem to recall warning that the U.S. dollar had moved to a huge oversold level late in 2009 and to extend a countertrend rally that could cause a short-term reversal in the basic materials complex — where we are still secular bulls.  But nothing moves in a straight line and this is more than just a countertrend rally in the greenback — having broken all its major averages in recent weeks.  Be positioned accordingly.  Since the onset of the credit crisis in 2007, there have seen three occasions when a surge in risk aversion caused a period of U.S. dollar strength on flight-to- safety trades — July 15, 2008 to September 11 2008 (around the GSEs);

September 22, 2008 to November 21, 2008 (post-Lehman financial collapse) and then from December 17, 2008 to March 5, 2009 (the final leg down in the financials).  Hereis what happened, on average, during these dollar-rally episodes — ultra-defensive strategies and heightened volatility:

• The DXY (U.S. dollar index) rallied an average of 12.3%.

• During these episodes, the Canadian dollar sank 11% against the U.S. dollar, but was only down 1.9% against a basket of non-U.S. currencies.

• The S&P 500 corrected an average of 18.5%.  Underperforming S&P equity sectors included materials, energy, industrials and financials.  Outperformers included utilities, staples, health care, tech and telecom.

• Despite the downdraft in commodities, the TSX performed in line with the S&P — losing 18%.

• In the TSX sectors, the winners and losers were different than in the U.S.A.:Financials and industrials actually outperformed.  Only materials and energy seriously dragged down the Canadian market.  As in the U.S., staples, health care, utilities, tech and telecom outperformed.  Outside of resources, the TSX sectors actually outperformed their S&P comparable.

• Still, it pays to note that we are talking about “relative” performance.  Every equity sector on both sides of the border was down during these periods.

• The oil price, on average, fell 26%, and gold was off an average of 11%.  The CRB index corrected an average of 22%.

• The VIX index surge an average of 34% during these U.S. dollar-rally episodes.

• We saw a bull steepening in the bond market — 2-year T-note yields plunge an average of 36bps while 10-year T-note yields dipped 8bps.

• Baa corporate spreads widened an average of 54bps; and by 268bps for high- yield bonds.

… more HERE.


… more HERE.