Many signs point to a dollar rally
With Europe mired in recession, China faltering, commodities declining and stocks looking vulnerable, investors seeking safety will look to the greenback.
A wide set of markets currently seem to be at a cusp, and the direction they go from here might require investors to take a radically different approach to protecting their wealth.
The case that changes are approaching is supported both by fundamental conditions in the economy and by our technical analysis of the charts. In the economy, several factors now coincide that should produce a deflationary effect on currencies generally. For example:
- The European zone is experiencing a recession, and some peripheral European countries are clearly in a depression. Consumer demand and the need for raw materials in that region have declined. Meanwhile, "austerity" policies have meant a withdrawal of economic stimulus with predictable effects on consumer spending.
- China is facing limits on the amount of monetary stimulus it can engage in without causing inflationary problems domestically. Thus, there is reduced demand for raw materials, particularly those used in construction, which has contributed to declines in several commodity prices.
- Reduced demand for resources means less export by countries such as Brazil, Russia, India, China, and South Africa (the "BRICS" nations) and correspondingly reduced consumer and government spending within those countries.
- In the U.S., indicators are mixed. There certainly have been some bright spots in economic news this year, but the whole picture is not one of an economy preparing for a growth surge. Corporate profits are starting to subside again, and it is now commonly acknowledged that the multi-year rally in stock prices has been driven largely by Federal Reserve actions and the widespread belief that those actions will continue as long as they are needed.
Ask yourself, if stocks were to experience a substantial correction for any reason, where would investors then choose to put their wealth? Similarly, what if the Fed were to withdraw its support of banks’ speculation in stocks? What if the Fed or the market itself were to raise interest rates by just a little, thereby increasing the drag on the economy? What if some other "black swan" event occurred that disrupted a substantial part of the domestic or global economy?
Each of these scenarios is credible, and each would probably result in a great deal of wealth retreating out of traded markets and being redeployed in cash or instruments closely correlated with cash. In the minds of most investors around the globe, the safest type of cash is the U.S. dollar.
It is possible that precious metals, especially gold -- represented by the SPDR Gold Trust ETF (GLD) and the Deutsche Bank AG DB Gold Short ETN (DGZ) -- also could draw an influx of wealth as it retreated out of other markets. Indeed, our own Elliott Wave analysis of gold suggests that it should eventually see another rally to new highs. However, a case can be made that gold could fall farther than most investors think it will before it locks in a low.
Turning now to our technical analysis, and for the moment setting aside economic considerations, what do the charts say about where the Dollar Index is headed?
With the price action during the last three months, the prospect of the dollar needing a new low is now even less probable. Our primary near-term bullish scenario for the dollar has become more attractive. Currently the dollar seems poised to break over the high of July 2012 in what could be a third wave inside a larger upward third wave or ‘C’ wave. Note also that the dollar is still in the upswing phase of the dominant cycle on the monthly timeframe.
A monthly close over 83.73 would probably eliminate the bearish alternate scenario entirely, and would cause the dollar to climb to at least 90.53 over the course of six to nine months.
On the weekly time frame, the form continues to look as though a corrective move completed late in 2012, which has set a base on which a substantial rally can build. This continues to be our primary scenario, with labels shown in green on the weekly chart below. Some preliminary targets for a rally in the Dollar Index include 85.50 and 89.58.
For the bullish path to continue, it would be best not to see a weekly close below 83.49.
From an Elliott wave view, the near-term bearish scenario is not entirely ruled out, and the dollar could require a new low before completing a large, downward ending diagonal pattern. The near-term bearish scenario is shown with red labels on the weekly chart. However, for several economic and technical reasons, the prospect of anything other than a dollar rally is becoming ever less likely.
More from Minyanville
Copyright © 2014 Microsoft. All rights reserved.
VIDEO ON MSN MONEY
Top Stocks provides analysis about the most noteworthy stocks in the market each day, combining some of the best content from around the MSN Money site and the rest of the Web.
Contributors include professional investors and journalists affiliated with MSN Money.
Follow us on Twitter @topstocksmsn.