Why You Should Watch The Dollar Closely Now

October 6, 2003
Mark Boucher

Weâ€™ve been advising investors since late June — when
the dollar began what we expected to be a bear market rally in an
on-going new secular bear market in the dollar — to watch the commodity
currencies for breakouts to new highs as an indication that the next leg of the
dollar bear market was developing for real. This week saw new highs in several
commodity currencies such as the South African rand,
Thai baht, and Australian dollar, with the
New Zealand dollar and
Canadian dollar on the verge of breakouts. The euro
has also climbed sharply and is not too far from breaking to new highs,
though is less strong than the commodity currencies as we have been expecting.
A move by nearby currency futures above 68.5 in the Aussie, 60 in the New
Zealand dollar, and 75 in the Canadian will confirm a new bear leg commencing in
the dollar â€” and a move by the Euro over 1.19 basis nearby futures will be the
final icing on the cake.

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As weâ€™ve
been saying for some time, whether the dollar decline is orderly and slow or a
crash will likely determine the direction of global stock markets in the next
two quarters, so it bears VERY close monitoring by
global investors. An orderly decline in the dollar that is accompanied by
rising forward earnings estimates, a rising stock market, a slow-declining bond
market, continued narrowing of credit spreads and the TED spread, and good
relative performance of cyclicals vs. defensives, can be market positive
IN THE SHORT-TERM.

But a
sharply declining dollar accompanied by a renewed downleg in global bond prices,
widening credit and TED spreads, and strong relative performance of defensives
over cyclicals, could kill this mini-bull market so fast itâ€™ll make your head
spin â€” and watch out below for likely new bear market lows. So far, the odds
favor a continued advance in global stocks in the intermediate-term and an
orderly dollar decline. But investors need to fully grasp the gravity of the
situation. The dollar decline is a tightrope walk and a fall from this high wire
act would mean global deflation likely.

Investors
should also move to protect themselves against a dollar decline if all the
currencies break the levels indicated above. Everbank (www.everbank.com)
offers money market funds in many foreign currencies and investors could also
participate via mutual funds like PSAFX (w/ 11.5 ops), as well as
forward-hedging, futures, and gold bullion (Austrian Coronaâ€™s) are alternative
investments investors need to look at much more carefully in a new dollar bear
market era.

Our base scenario for a global
recovery of sorts is still the highest-likelihood scenario, but there are
growing risks to it. While the market could easily undergo a minor correction
taking many weeks at any time, we would expect a recovery to develop as economic
news continues to confirm our base scenario and it is looking increasingly like
a much stronger growth period than markets are anticipating, is ahead. Asia
should continue to lead on the upside, although a consolidation or correction is
long overdue. Our favorite markets are now small-cap Emerging Markets in
general, metals and resources, South Africa, Eastern Europe, Chile, India, Latin
America in general, and Asia in general. Asian funds doing well have a strong
allocation to Hong Kong, the one Asian country that will benefit from any dollar
depreciation versus the rest of Asia.

Investors should continue to monitor the potential party killers â€” 1) over
4.75% on 10-year government bonds (more reprieve here); 2) oil over $38-$40
(much more reprieve here, though $25 should hold); 3) a fast-plummeting dollar;
and 4) a CLEAR and strong successful terrorist attack in the US or on a major US
installation.

Gold and silver and related stocks continue to creep ever higher in what we
suspect is the early stages of a new secular advance. But remember these metal
plays are always VOLATILE. Also moving up nicely
are base metal and other resource plays. The CRB should continue higher before
229 is breached after the recent breakout, as should industrial commodities in
particular (Rogers Raw Materials Fund).

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Investors should continue to cautiously add stock exposure as trade signals are
generated that meet our strict criteria, as well as allocate to our favorite
segments. Our model portfolio followed in TradingMarkets.com with specific
entry/exit/ops levels from 1999 through May of 2003 was up 41% in 1999, 82% in
2000, 16.5% in 2001, 7.58% in 2002, and we stopped specific recommendations up
around 5% in May 2003 (strict following of our US only methodologies should have
portfolios up over 11.5% ytd by our calculations) â€” all on worst drawdown of
under 7%.

Last week in our Top RS/EPS New Highs list published on TradingMarkets.com, we
had readings of 12, 5, 17, 14, and 23, accompanied by just 3 breakouts of 4+
week ranges, no valid trades and no close calls. Internal strength has really
plummeted in the market. Position in valid 4 week trading range breakouts on
stocks meeting our criteria or in close calls that are in clearly leading
industries, in a diversified fashion. Bottom RS/EPS New Lows are still quite
weak with readings of 3, 4, 3, 2, and 1, with 1 breakdown of a 4+ week range, no
valid trades and no close calls. The short-side remains bleak. Selling
pressure is very low â€” the problem is that buying power is just mediocre and
starting to drop.

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For those not familiar with our long/short strategies, we suggest you review my
book

The Hedge Fund Edge, my course “The
Science of Trading,”

my video seminar, where I discuss many
new techniques, and my latest educational product, the

interactive training module. Basically,
we have rigorous criteria for potential long stocks that we call “up-fuel,” as
well as rigorous criteria for potential short stocks that we call “down-fuel.”
Each day we review the list of new highs on our “Top RS and EPS New High List”
published on TradingMarkets.com for breakouts of four-week or longer flags, or
of valid cup-and-handles of more than four weeks. Buy trades are taken only on
valid breakouts of stocks that also meet our up-fuel criteria.

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The dollar bear market is a MAJOR story and trend
that all investors need to understand, watch carefully, and defend against. The
likelihood remains that the markets should march irregularly higher, two steps
forward and one step back as long as liquidity is plentiful, global economic
acceleration continues, and breadth holds up. But instead of the normal pattern
of liking a market more the stronger it gets, in this expected mini-bull move,
investors should be growing more cautious as the market rallies from here.

Mark Boucher

Why You Should Watch The Dollar Closely Now

BUY THE FEAR, SELL THE GREED

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