Do or Die for the Dollar

Over the past few days, we have seen an massive unwind of long energy, short financials, long commodities, short stocks, short dollar, long....well every currency versus the dollar. The selling has been brisk and aggressive and traders, much like the days where the Yen was the carry of choice, are fretting an environment where the dollar is strong and everything else is weak. Are traders jumping the gun early on this? Well, 3 things of my models are on the cusp of moving higher for the dollar.

First, technically, things are looking like something is about to happen. The dollar index is very close to breaking back above the 73.95 range level on the long term chart. A successful close above this level at month end would be the first since the spring. It would also confirm to me a double bottom of sorts around the 71.70 level. Using straight projection analysis, this implies a move towards the 77 level, which in turn argues for the Euro to end up somewhere in the 1.45 area. Shifting to the weekly, the same setup is seen in terms of the projection but the next major range level I show is near 82 or roughly 1.20 in the Euro.

The second and third major factors are somewhat related. First, my gold versus dollar model, which has favored the yellow metal since the beginning of 2002, is moving in the direction of a reversal though more aggressively on the gold side than on the dollar side. A break in this ratio implies a bear market for gold over the next few years. A bear market in gold implies a bear market in commodities. A bear market in commodities, argues for a bear market in commodity currencies.

And you probably just guessed what the third factor is: Commodity currencies (and the swiss franc). The Canadian Dollar (ie the Loonie) and the Australian Dollar (ie the Aussie) are both on the verge of horrific collapses lower, if you happen to be long. In my weekly note I post to friends (I don't post it on the web for a variety of reasons), the one constant I see with these commodity currencies is large gaps to .8750 in both the Loonie and Aussie from current levels. I mentioned in the market views piece that a break of $120 in crude oil, argues for a swift fall to the $110 level and lower. This could very well tilt these two currencies over and push the dollar index higher as a result.

Combining these factors together and you get an explosive move in the dollar to the upside. My guess is that the currencies will move after the ECB meets on Thursday. To be honest, with growth expected to be lower than last quarter in the 1.5% range and 1% in the following quarter, the fair value of the ECB target is coming down dramatically, regardless of where inflation falls when officially reported in a week. This means that the next path for rates is lower and not higher. Lower rates while the Fed is stable implies a lower Euro as a result. Thus, Trichet in a way holds the key - dollar rally now or dollar rally later. I guess we'll know more Thursday.