Consequences of a Falling Dollar

Not only have we experienced a terrific market rally since March, we have also experienced a falling US Dollar. A steady chorus of international voices making a strong case for a global reserve currency, helped to fuel the dollars decline. Unfortunately, one can also point to our domestic fiscal policy. The decline of the dollar has a number of consequences for cash assets held domestically; one being more expensive foreign goods (imports). The dollars decline has contributed to the bullish backdrop underlying many other asset classes - such as commodities and foreign securities. As it takes more dollars to buy the same amount of ‘stuff’, commodity consumers will often stock pile to avoid making future purchases with a weaker currency, while precious metals are often purchased as an inflation or purchasing power hedge.

One beneficiary of the falling dollar has been Gold, which has moved above $1,000/oz. to register new all-time highs; at least in US Dollar terms. Interestingly, in terms of the Euro, we find that Gold is still well below its highs from February of this year.
Gold, as an asset class, offers a strong outlook based upon its trend chart however, its outlook in terms of leadership within the commodity asset class and even the Precious Metals segment of the asset class, is much less attractive. The proxy for silver (DBS – PowerShares DB Silver Fund) gave a relative strength buy signal versus Gold earlier this year and continues to exhibit positive strength vs. gold.
Silver has outpaced Gold’s proxy (DGL – PowerShares DB Gold Fund) rather dramatically thus far in 2009: DBS +45% to DGL +14% and, for the reasons mentioned above Silver appears likely to continue doing so.
Where appropriate for accounts under my advisement, DBS is part of the commodity exposure - along with DBB (PowerShares DB Base Metals Fund). The commodity group as a whole typically benefits from a falling US Dollar however, some commodities will inevitably benefit more than others during any market cycle. Going back to 1990 the average annual differential between the best and worst performing commodity is 114%*. Tactical asset allocation allows me to ‘hand pick’ exposure to the stronger areas within commodities, providing us with the opportunity to do better than a non-tactical approach like ‘buy and hold’ the broad commodity asset class. For example, while the trend for the overall commodity asset class continued higher in September, the trend of Crude Oil was derailed in recent months; oil prices stalled in early August when a high was placed at $75 per barrel. This is a negative divergence from the other raw materials.
For now it appears that metals, as a sub-group within commodities, are best positioned to provide outperformance and, despite Gold’s recent highs, Silver is in a lead role for the time being.

*Dorsey Wright - October 7, 2009