Dollar Update - How low will it go?

12/18 UPDATE:
1st Target $77.81 met! We bounced off of a low yesterday of $77.69 and are seeing strength. This provides an early cue to trim or hedge commodity related positions. See updated chart at http://screencast.com/t/VgLFKk1AN9v

Implications? Commodity related positions (Gold, fertilizer and oil stocks) will likely deteriorate with Dollar strength. ***************************************************************************************

The object of technical analysis is not to simply to forecast but to identify attractive risk/reward opportunities. In previous posts we highlighted the Dollars peak and its subsequent slice through major support. In the process it flashed a textbook signal - a Head and Shoulders pattern. This signaled an intermediate trend change.

If you been reading and have taken advantage of this signal with appropriate currency pairs or going long commodities you should now be wondering how far will the slide last? More appropriately you should be asking at what point does the Dollar short cease be an attractive risk/reward? The chart below provides some helpful clues.

There is a convergence of indicators pointing to a near term target of $76-78 for the US Dollar index.

• Head and Shoulders: First we see a clear representation of a Head and Shoulders pattern expressed on the US Dollar Index. A rule of thumb for H&S patterns is the height above the neckline is often matched by an equal depth below the neckline. Using a Fibonacci tool this implies a target of $77.81
  
• Moving Average: The 200 DMA is nearing $77

• Support levels: We see prior support coming in at $76. A prior resistance level at $80 was never tested and probably won't be much of a factor.

Alternate indicators: The RSI and Stochastics (highlighted in red) are entering oversold values. Simply reaching these values is not an automatic signal to cover (or buy long), but you should be paying close attention here.

The MACD is still very much bearish and persisting in that trend, but should be watched closely as well. This indicator will most likely provide the earliest signal for a rebound. A great tutorial on this important tool can be found here. I will be looking for an early divergence in the histogram followed by a crossover of the moving averages.


Why is the US Dollar so important? Take a look at the inverse relationship of the US Dollar and Commodities. Commodity related stocks have been coming to life, notably Gold and miners (GG, ABX) and to lesser extent Fertilizer stocks (CF, MOS, POT) and still lesser oil. Their performance is magnified by the action in the dollar.

In the Macro economic picture we experienced violent deleveraging. We continue to experience deflation as a result of credit contraction. There is a massive effort to offset the destructive effects of these by the Fed. The result has been a sharp increase in money supply -see "Bernanke's game plan" in the side bar. This new money is still being hoarded by banks seeking to shore up their balance sheets, but eventually it will make it's way into the market.

Long term it is clear the FED views a depreciation of the US dollar and even a sharp devaluation as an attractive monetary policy. Europe, Latin America and most notable China have all began to loosen (depreciate) monetary policy in a tactic know a "Beggar thy Neighbor" economics. Investors now should be worried about the value of the dollar going forward. A short term rebound of the dollar as indicated in the first chart may provide an second opportunity to enter commodity related issues at a discount or make follow-up buys.

Not all commodities are created equal. While commodities in general will "benefit" from a depreciating Dollar the world economy is deteriorating. Demand destruction remains a factor in energy related commodities, less so in Agricultural, and least so in precious metals. Gold in particular is faring nicely despite deleveraging, deflation and demand destruction (jewelry). The main reason is monetary uncertainty creates demand in Gold and to a lesser extent Silver.

It's time to pay attention.