We're About to See a Massive Rally in the Dollar

By Tom Dyson, publisher, The Palm Beach Letter
Tuesday, August 11, 2009

My mother has a perfect record of timing the market. She always buys and sells at exactly the wrong time.

She bought technology stocks a week before they collapsed in 2000, for example. And earlier this year, she sold her stock in Royal Bank of Scotland the same week it began a two-month, 300% rally.

When my mom called yesterday, she told me she'd liquidated her stash of dollars and converted them into pounds.

And it's not just her. The whole world, it seems, is bearish on the dollar...

The Daily Sentiment Index measures the percentage of bulls and bears among futures traders. Last week, the Daily Sentiment Index for the Dollar Index showed just 3% bulls... a level that's only been reached five times in the past 20 years, according to Robert Prechter's Elliott Wave Theorist.

Meanwhile, the Daily Sentiment Index showed 90% bulls for the Swiss franc, 91% bulls for the British pound, 96% bulls for the euro, and 98% bulls in the Canadian dollar.

When sentiment gets this lopsided, you can expect a massive trend change. For example, between March and July 2008, bullishness toward the foreign currencies and against the U.S. dollar reached similar levels to where it is today. At its worst, there were just 5% bulls on the Dollar Index.

These sentiment readings marked the start of the largest, most powerful rally in the dollar in 10 years. Here's the chart of the dollar index. It measures the performance of the dollar against a basket of the world's major currencies. Look at this powerful rally...

Now that sentiment has returned to similar levels, I expect we're about to see another huge trend change in the currency markets. The dollar will soar, and the major foreign currencies will decline.

Betting against the euro is my favorite way to play this. Sixteen different countries use the euro... and most of them are experiencing severe economic pain right now. Countries like Ireland and Spain are entering deep depressions. A cheaper currency would help these countries soften their recessions, ease debt loads, and stimulate exports.

Germany is the largest economy in the euro area. It's the world's largest export economy in dollar terms. A high exchange rate hurts the German labor market by making its products uncompetitive.

My bet is, politicians from all the different euro countries are about to put enormous pressure on the independent European Central Bank to ease monetary conditions and manage the euro's exchange rate lower. Some countries may even threaten to leave the euro if the European Central Bank doesn't oblige.

This political pressure will usher us into a new period of weak euro exchange rates. I wouldn't even be surprised to see this pressure push the euro to parity with the dollar again one day.

There's an exchange-traded fund (ETF) for the euro. The symbol is FXE. You can short it, or buy long-dated puts on it. Or you could buy the PowerShares DB US Dollar Index Bullish (UUP). This ETF rises when the Dollar Index rises. As the euro represents 58% of the dollar index's weighting, it's a close proxy.

Good investing,

Tom

Further Reading:

My Favorite Speculation in the Coming Dollar Rally

This Smart-Money Indicator Points to a Dollar Rally

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THE CASE OF THE DISAPPEARING VOLUME

OK... it's skeptic's corner time.

Old market pros keep a close eye on "volume" trends in stocks. Put simply, if stocks in general are increasing in value on high and rising trading volume, it says investors are putting real money to work in the market. If the market is rising on low and dwindling trading volume, it's a danger sign... a sign folks who control billion-dollar investment funds aren't buying with conviction.

Today's chart is of the S&P 500 ETF (SPY). It's one of the largest investment funds in the world... and an excellent gauge of the stock market in general. As you can see, it's been soaring since March. Now, here's the skeptic's take...

Our chart features an extra pane at the bottom that shows SPY's trading volume. The dark bars display trading volume on days SPY advanced. The red bars display trading volume on days SPY declined. The taller the bar, the greater the volume. As the SPY has climbed higher and higher, market participation has gotten weaker and weaker.

Unless the "big money" gets back from vacation and starts buying up shares, one has to take the Jerry Maguire approach and say "show me the money..."

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