For a while I have been predicting a decline in the U.S. dollar, which has not come to fruition. However, I believe my predictions have just been a little premature. The dollar is still benefiting from safe-haven flows, but it’s only a matter of time before the trend shifts, and that should help drive commodities higher.
The factors I have been looking for to prompt a decline in the dollar are still in place; namely, the huge bailout plans that have already been instituted. With a Democratic president being sworn in to office last week, I think economic stimulus spending will only increase in the near future. To finance this spending, the government must issue new debt and continue to print dollars, increasing the money supply. This increase in money supply is very bearish to me, and I still believe we will see a substantial drop in the dollar. The recent run-up in the dollar indicates to me that investors are still looking for safe havens, as economies around the world continue to struggle. Many seem to believe the U.S. dollar is the safest place to invest. With interest rates nearly at zero, I thought we would see more investment in the euro currency, as the European Central Bank (ECB) has not dropped rates as much as the Federal Reserve has. ECB policymakers have made comments that they will not lower rates significantly unless they see risk of deflation.
The week of January 19, 2009, the Eurozone Purchasing Managers’ Index, a reading on manufacturing, was reported at 34.5, versus an expected 33.2, and a previous level of 33.9. Is this good news? Only time will tell. This report is generally not a major market-mover, but it is a good indicator of the overall health of the economy. It is still well below 50, a level which indicates an expected increase in business conditions, but could offer a glimmer of hope that the beginning of the recovery is not all that far away. We will have to watch new indicators for confirmation, but if this is the case, I believe investment will shift from the U.S. dollar to the euro.
Treasury Prices Slip; Gold Gets Safe-Haven Flows
We have recently seen a sharp decline in U.S. Treasury prices, which I believe indicates a lack of faith that the government will be able to curtail stimulus efforts once the economy turns a corner. I think we will continue to see declines in bond prices as people demand higher yields to hold long-term government debt. The yield on the 10-year Treasury note hit a six-week high on speculation that China, the largest overseas holder of U.S. government debt, will purchase fewer Treasuries. A further decline could be coming soon. China could potentially make a statement about buying Treasuries in response to comments from new Treasury Secretary Tim Geithner last week that accused China of manipulating its currency. I believe any comment will come after the Chinese New Year celebrated Monday, January 26, so watch for major market moves.
The negative for U.S. Treasuries becomes a positive for gold as people seek a new safe haven, which will benefit from excessive stimulus (i.e., a weak dollar). Gold prices rallied $55.90 an ounce the week of January 19, or 6.6 percent. The majority of that gain came Friday, January 23, as front-month gold futures broke out above a downward trendline from the July 2008 peak price of $1,004.10. I believe there will be continued bullishness in gold in the coming months as a weak dollar causes inflationary pressures in the U.S.
With the return of inflation, I think we will see the return of the commodity bull market in the near-term, and it may have already begun.
Crude Oil Volatility Remains
Crude oil prices were up $3.90 a barrel last week, representing a 9 percent gain. I believe we will continue to see high levels of volatility, so I think there will be opportunities to buy pullbacks in this market, near $42 in March crude oil and near $45 in the April contract. I believe the potential weakness in the dollar will have a large impact on crude, as it did when we hit nearly $150 in the summer of 2008. The Energy Information Administration (EIA) estimated that demand is down 2.66 million barrels per day from July. Bloomberg reports that supply is down about 2 mb/d to 27.45, but comments from Saudi Arabia indicate that level may be down under 27 mb/d. This decrease in supply has effectively removed excess supply from the market, as OPEC indicated it would.
According to the EIA, we have seen a week-over-week increase in demand almost every week since October, when the economy appeared to be at its worst. On a technical basis, the market seems to have formed a nice rounded bottom, and I think we will see prices continue to move higher with a target of $49 to $55 within the next two weeks. As we see crude oil prices rise, watch for a bottom in natural gas prices as well. I think there will be major support at $4.30 mm/Btu, and an opportunity for getting long should soon present itself.
Fundamentals Support Grains
Finally, as well as inflationary pressure from a weak dollar, there are other fundamental factors that I believe will cause rallies in the grains. The weather in Argentina has been very dry, causing a large drop in production estimates for this year. Soybean production is estimated to be down 17-25 percent from last year to between 35 and 38 million tons. The U.S.D.A estimated production of 49.5 million tons. Corn has seen an even larger drop in estimates of 33-40 percent, to 12.3 to 13.7 million tons, with the U.S.D.A. predicting 18 million. South Korea, the world’s third largest importer of corn, showed an increase of 5.2 percent in imports last year.
Wheat production has also been impacted by the lingering drought, causing estimates to drop to 8.2 million tons from 9 million, compared to 16 million last year. Argentina has begun rejecting export permits due to fears of insufficient domestic supply. I believe there will be great opportunities in the grain markets in the coming months. I recommend using options though, due to high volatility. We may see large drops as the weather changes, but I think the trend will continue higher as any moisture may be too little too late.
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