Will A Strong Dollar Crush Stocks, Silver, and Gold?

• By Simon Maierhofer
• On 12:25 pm EDT, Tuesday June 23, 2009

The market is devious and will often do the opposite of what most investors expect.

We've seen numerous examples of that behavior lately. A strengthening dollar came out of left field for most investors who rely on the financial media to make their financial decisions. Due to the government's lack of fiscal responsibility, a prolonged slide of the dollar's value was a foregone conclusion by many.

According to the main stream media, the recent decline of gold, silver, the S&P 500 (SNP: ^GSPC), Dow Jones (DJI: ^DJI) and Nasdaq (Nasdaq: ^IXIC) was caused by a strengthening greenback. True, a rising dollar means different things to different asset classes, but what does it mean for the economy, stocks, gold, and silver.  Furthermore, can the dollar maintain its strength?

Can the dollar stay strong?

If you've been reading our articles, you know that our view tends to be contrarian in nature. This has served us and our readers well.

Concerning the US dollar, the ETF Profit Strategy Newsletter wrote the following on June 3rd, one day after the dollar started rallying: 'Against popular belief, the US dollar should actually remain strong, at least for the next 1-3 years. Why? Extreme bearish sentiment surrounding the US dollar is pointing towards a rally which should begin shortly, if it hasn't already.'

This is truly a contrarian view. If you are anything like me you demand an explanation, and rightfully so. The newsletter continues as follows: 'The sheer amount of outstanding US debt should prove bullish for the longer term. Here's why: The US dollar is by far the most inflated currency. It is also the most commonly used currency in the world. As such, most of the debt - and toxic assets - in the world is US dollar denominated. As those toxic assets continue to deflate, US denominated wealth will continue to shrink. The law of supply and demand teaches us that scarcity of any product results in higher prices. In other words, the fewer dollars in circulation the more valuable the remaining dollars will become.

ETF profit opportunities linked to the US dollar tend to be small due to the relatively small percentage moves of the dollar. To illustrate, from its March high of 89, the US Dollar Index dropped to 78 before rising to 81. The corresponding ETF, PowerShares DB US Dollar Index Bullish Fund (NYSEArca: UUP - News), fell 12% top to bottom, while the PowerShares DB US Dollar Index Bearish Fund (NYSEArca: UDN - News) gained about the same amount. Going forward, UUP will be the better option.

The dollars effect on commodities

Even though there are no huge ETF profit opportunities directly linked to the dollar, knowing the dollar's direction sets up bigger profit opportunities in other markets.

Since most commodities, including oil, silver and gold, are traded in US denominated dollars, a rising dollar exerts pressure on commodity prices. This, however, is not the only factor that drives commodity prices. There are a number of other factors that need to be taken into consideration. Price non-confirmations are one of them.

On June 3rd for example, the ETF Profit Strategy Newsletter noted such a non-confirmation (see chart below) between gold and silver prices and commented as follows: 'This bearish non-confirmation creates downward pressure for both metals. The fact that tons of money pouring into gold failed to propel prices to new highs, also signals trouble ahead. As the base of gold owners and Goldbugs has skyrocketed, there is now a bigger pool of gold owners that can morph into sellers, putting more pressure on prices. A rising US dollar should further compound the pressure on gold prices.'

ETFs recommended, along with the above given analysis, included the UltraShort Silver ProShares (NYSEArca: ZSL - News) and UltraShort Gold ProShares (NYSEArca: GLL - News). ZSL has gained about 25% since.

Additionally, investors could have shorted the iShares Silver Trust (NYSEArca: SLV - News), SPDR Gold Trust (NYSEArca: GLD - News), or iShares COMEX Gold Trust. The down trend for gold and silver should last more than just a few days/weeks (more about that later).

The US dollar and stocks

Over the past year there has been a strong inverse correlation between the US dollar and US stocks. Stocks rally as the greenback declines, and vice versa.

A strong dollar causes prices of US-made products to increase overseas, which often results in slimmer profit margins and lower stock prices. The inverse scenario applied for international exporters, such as Toyota. For every yen gained against the dollar, Toyota's operating profit slips by about $400 million (annually). Toyota is a top ten holding of the iShares MSCI EAFE ETF (NYSEArca: EFA - News).

Economically sensitive sectors such as the Consumer Discretionary Select Sector SPDRs (NYSEArca: XLY - News) tend to be more sensitive to currency fluctuations than defensive sectors, such as the Healthcare Select Sector SPDRs (NYSEArca: XLV - News).

The inverse relationship between stocks and the dollar harmonized well with the ETF Profit Strategy Newsletter's forecasts, such as the one from December 15th: 'Optimistic sentiment, which should be more visible above Dow 9,000, will give way to further declines. These should draw the indexes close to or below their November 21st lows of 7,445 for the Dow (DJI: ^DJI), and 740 for the S&P (SNP: ^GSPC).'

After briefly poking above Dow (NYSEArca: DIA - News) 9,150 on January 6th, the composite dropped 30% within 30 days.

A special Trend Change Alert issued on March 2nd, four days before the S&P 500 bottomed, foretold the following: 'A multi-month rally, the biggest rally since the October 2007 all-time highs, should lift the indexes by some 30-40%. Tuesday's 4% spike may be an indication of the initial intensity of the rally.'

True to the inverse correlation, the US dollar rose as the S&P 500 (NYSEArca: SPY - News) dropped earlier in '09, and fell as stocks rallied from their March lows.

Once again, a strengthening dollar has spelled trouble for US equities. From the very beginning, we have considered the rally from the March lows to be a counter trend rally. Even though it doesn't seem complete as of yet, the down trend will eventually resume.

The ETF Profit Strategy Newsletter relies on a composite of reliable long-term indicators to provide long-term guidance. Unlike news based research, which tends to be good towards the top and bad towards the bottom, this composite of indicators has an impressive track record of accuracy. The March and June Newsletter issues include a detailed analysis of several indicators, along with an outlook for gold, silver and a target range for the ultimate bottom in stocks. 

Buzz up!