Jamal Mecklai: Has a serious dollar rally begun?

Nothing moves in one direction forever, and after 10 years, it was inevitable that the greenback's bear phase would come to an end

A few days ago, a friend from Karachi sent me some data on gold price movements since 2001 showing that each peak was hit about 20 months after the previous one, and was higher by an average of some 30 per cent. Extrapolating from this, he wondered whether gold would reach about 2,600 in April 2013.

I told him that my view was exactly the reverse. I think we are on the threshold of a significant dollar bull trend, and that gold, rather than rising to 2,600, would more likely move towards 1,200 over the next few years.

The serial highs hit by gold since 2001 were, in many senses, a reflection of the fact that the dollar was on a long-term bear trend, with the DXY falling from over 120 to a low of 72. Before that, the dollar was the only game in town — gold was a forgotten asset at under $300, the euro had just been born and had little credibility, and Japan was scrabbling around on the ground. The lost decade, they called it. The dollar was the only place to put your money, and by the end of 2000, it looked like dollar strength would never end.

I remember, at that time, I had asked Pramod, who worked with me and was – indeed, is – perhaps the smartest market analyst I know, to come up with a set of scenarios that could push the dollar lower. Three months of brainstorming led us nowhere — we couldn’t come up with a single credible scenario for a weaker dollar.

But, of course, the dollar did turn and start – and continue – falling. I had to relearn the lesson that it is impossible to forecast a major turning point before the fact. The best you can do is trust your gut, and, of course, watch the market.

For the past two years or so, I have had a feeling – driven simply by the knowledge that nothing moves in one direction forever, and 10 years is a long time – that the dollar’s bear trend was approaching its end. Kind of confirming this, the DXY has been strengthening recently, and has gained nearly 10 points (a bit over 13 per cent) since its all-time low in April 2011.

But 13 per cent is not a major trend. Bull markets are defined as a minimum 20 per cent rise, and during the dollar’s bear phase, the DXY fell by 47 points (or nearly 40 per cent) from its peak 2002. So, if this is the start of a major bull run, there could still be a long way to go.

As I think about it, it’s back to 2000, with the euro losing credibility fast, and the yen and gold already much too high to provide comfort for nervous money. The dollar is, once again, the only game in town.

In which case, why is the DXY still around 82 or 83? Why hasn’t it shot up to 90 or more?

Clearly, the market has obviously not fully bought into dollar bullishness. There are more and more believers, but sentiment is still tentative. Perhaps, there are concerns that when Barack Obama wins re-election in November, US markets will sell off, since he is perceived as less pro-business than Mitt Romney. This concern could explain the dollar edging higher on last week’s disappointing June employment numbers, which was seen as negative for Mr Obama.

Another reason that the market may be circumspect could be the now-near-certain belief that the euro will break up. Depending on how that happens, the new Deutsche mark (or the new euro) would certainly appreciate, attracting huge funds, which could also put a hefty dent in a dollar bull run.

If I am correct, the stronger dollar should – and would – filter into USD/INR; thus, if DXY went up to 95 (a 15 per cent rise) over the next 12 to 18 months, USD/INR should rise by Rs 7-8. On the flip side, dollar strength would push commodity prices lower, making India’s current account deficit much easier to finance. This, in and of itself, should improve sentiment, earning back at least Rs 2-3 of the decline. If, in addition, the euro broke up and the new regime settled in, say, a year or so, we could see a huge boost to global sentiment, which could bring investment flows pouring back into India and get the rupee moving back towards 50.

My guess is that during 2013 and 2014, we will see both 65 and 50 to the dollar.

 

jamal@mecklai.com