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Tuesday, September 23, 2008

Are Commodities Bottoming? Keep Your Eye on the Dollar

After the market seemed to suffer cardiac arrest last week, it quickly developed a split personality on Monday, as traders waited to see how the Federal bail-out of bad bank debt shakes out. Many stocks had a miserable Monday … but not commodities.

Indeed, gold, oil, silver and more all headed higher, with gold futures rising more than 5% on Monday to end above $900 an ounce for the first time in seven weeks. Oil went up by a single-day record. And the Reuters/Jefferies CRB Index soared to its biggest gain in more than five decades!

Sure, part of it was that Monday was the last day of trading for the October oil contract. But the fact is, commodities seem to be bottoming. Why is this happening? Because A) the government is injecting hundreds of billions of dollars into the system to provide liquidity, B) the wave of selling by hedge funds seems to be over for now and C) the US dollar pulled back and could go lower. In fact, Monday saw the U.S. dollar’s biggest one-day decline against the euro since 2001.

Just take a look at this daily chart of the US dollar Index and you’ll see what I mean. You can see that the US dollar has broken its short-term uptrend. At the same time, RSI, a momentum indicator, has made a double-top. This can be an indicator that a significant top has been put in.

And by looking at a weekly chart of the dollar we can get a view of the big picture. You can see that the dollar broke out of its long-term downtrend, but is now going lower. Oftentimes, after a breakout, a future, stock or index has to go back and test its former downtrend as support. That may be what’s happening here.
Just to make things more interesting, stocks, futures and especially currencies never travel in a straight line. So, after Monday’s sharp sell-off, we could see a rally in the greenback before it continues its downward path.

Commodities are priced in dollars, so usually, as the dollar goes down, commodity prices go up and visa versa. A lower dollar also makes US grains more affordable for foreign buyers because the price doesn’t go up so much for them as the greenback falls against their currency. So, this can ignite another round of commodity buying. Gold in particular seems to be reacting very positively to the dollar's pullback.

Indeed, strong-dollar talk from Washington is just that, talk. A weaker US dollar was a tremendous boost for US exporters, and was finally starting to have an effect on our trade deficit. So it wouldn’t be surprising to see the White House quietly encourage the dollar to go lower and lower still.

News You Can Use

Dollar Trades Near Weakest in Month Before Testimony by Bernanke, Paulson The dollar traded near a one-month low versus the euro as Federal Reserve Chairman Ben S. Bernanke said in the text of his Senate testimony that failure to pass the U.S. financial bailout would threaten the economy
XX Sean's note -- the dollar has rallied from its lows. Lately, I've noticed that Bloomberg offers plenty of news but little insight.

Oil Falls on Concern U.S. Economy Won't Avoid Recession After Bailout Plan Crude oil fell for the first time in a week, paring yesterday's record gain, as declining stock indexes signaled investor concern over a U.S. government bailout plan for financial companies.

XX I believe this is incorrect. It's more likely that oil is pulling back because of A) its strong rally yesterday and B) a counter-rally in the US dollar today.

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