Thursday, March 13, 2014

US Dollar Update - Something to watch this weekend

We have noted that what happens to the US dollar is the most important thing we can keep an eye on here. If there is going to be major monetary system change, it will most likely involve a change of status for the US Dollar from its lofty position as global reserve currency. We added the US dollar index quote on the upper right side of this blog as a handy way to see the current market price. With the tension in the Ukraine coming this weekend, this dollar index bears watching to see how it reacts.

Jim Sinclair ran this fairly lengthy but good article on the dollar which provides some more information on why it is important. The article is written by Bill Holder of Miles Franklin. The bottom line to all this is that if you want two things to watch to let you know if we are getting closer to possible major changes, they are the price of gold and the US dollar index. 

In general, if the US dollar is falling in value, gold tends to go higher. In reality what is happening is that the dollar is simply losing purchasing power versus gold. If this trend continues over a long period of time and the dollar falls below key support levels, it is a strong indication that there are serious problems somewhere in the monetary system. This is why Central Banks (including the US FED) do not want to see a sharply rising gold price or sharply falling dollar.

If that does happen, investors will become more worried and will tend to just "pile on" and speed up the process of exchanging dollars for hard assets. If confidence in the dollar gets too low, people will simply start trying to trade dollar investments for whatever they think will maintain purchasing power. Historically that has been gold (and probably silver as well).  Other hard assets as well, but gold and silver are usually the first choice. 

On the flip side, if you see the US dollar strengthen, it means investors are still confident in dollar related investments. It is not troubling to Central Banks for these prices to fluctuate in normal trading ranges. It is troubling if they start moving too much too fast. This is what we have to watch for carefully at all times given all the global debt today. 

In addition, we still have too big to fail banks holding huge derivative positions. It is an unknown what the true market value of all these derivatives really are. If one or two big financial institutions fails, it could lead to a chain reaction in these derivative holdings across the system. Such an event would likely trigger a free fall in the US dollar and shake confidence in the current monetary system to the core. 

So far the system is still holding together. No one can know for sure how long that will be the case. It could change at any time or it could stay stable for quite a while longer. Just use your two simple guides as your first warning signs. The price of gold and the US dollar index.

added note: One thing to keep in mind if a worst case scenario did happen. There is a lot of gold held by the IMF and Central Banks. In a bind they can always use that gold to restore confidence and stability. It's not their preference to have to do that because that means things are in bad shape, but they can use gold and in my opinion would use gold if it became necessary. I think there is a lot of misunderstanding about how Central Banks really view gold.

Gold will be at a much higher price in that scenario unless they lose the battle against deflation. But if that happens, gold will likely still gain in purchasing power versus everything else (lets say your house drops 50% in value, but gold only drops maybe 20% in price for example). You can be sure that the Central Banks fully understand this in my opinion. Also, the FED will do everything it can to fight deflation because deflation hurts debtors. The US is the biggest debtor out there. Falling asset values would almost surely led to US debt default at some point sooner than later.

update 3-14-2014: the dollar index has now fallen below a key level at 80 and is having difficulty getting back above that number. The Ukraine situation remains volatile. The big key now is the 79 level. If the dollar cannot hold 79 it is likely to start into a sharper decline. Next week will be important in terms of seeing how this index reacts.

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