DOLLAR WEEKNESS, CONTINUATION OF THE RALLY IN EQUITIES
Published on Saturday, September 12th, 2009 at 1:29 PMAuthor: Munish Rao (11 Articles)
Dated: 10th Sep’09
DOLLAR WEEKNESS, CONTINUATION OF THE RALLY IN EQUITIES
Dollar continues to be week; precious metals have been strong; what about the equities? Since its bottom during early Mar’09, the global equity markets have rebounded more than 50%. Will this strong recovery sustain? Or are the markets forming a bull trap for those who feel so? During the last few weeks, the only asset class which has shown strong rally has been precious metals especially Silver and Gold along with a continued weakness of the ‘Greenback’. DXY (Dollar Index) has declined 13% since 6th Mar’09 to 77 levels from 88.5 levels then. Technically markets were very much oversold during that period when they started to recover. Several experts posted comments like ‘start of the beer market rally’ for this move. But this beer market rally turned out to be a strong trending bull market where the equities have moved in one direction. Thanks to improved investor interest towards this asset class supported by better economic news globally.
Now the markets are at a point where the investors are double minded whether the current trend will continue of a correction is in the making anytime soon? I was a no exception from this group and having similar thoughts. But the recent rally in precious metals which has been ‘fast & furious’ as the dollar continued its weakness during last few weeks is suggestive of the further rise in the equities. The dollar has declined around 16% against the Canadian Dollar, 13% against the Euro, 6% against the Yen and 15% against the Pound since 6th Mar’09. Against the INR the decline is close to 6.5% for the same period.
Source: Pacific Exchange Rate Service
Bailouts, the key reason for increased supply of the dollar
Considering the impact of the financial crisis, U.S. Treasury Secretary Henry Paulson proposed a plan under which the U.S. Treasury would acquire up to $700 billion worth of mortgage-backed securities. The plan was immediately backed by President George W. Bush and negotiations began with leaders in the U.S. Congress to draft appropriate legislation. Finally a $787bn stimulus package was approved and now the White House is predicting a budget deficit of $9tn over the next 10 years. These huge deficits will fan inflation fears and keep downward pressure on the dollar. The government has been raising more money through the issuance of new Treasury bonds. More and more dollars being printed along with rising debt has created more supply of the greenback than its demand. One thought that arises from this is that if the recovery is real, the deficits should actually diminish as the tax revenues from the corporate and the general public will rise.
The September Effect
Over the last four decades, September has been the best month for gold in terms of its month-over-month price appreciation. The average percentage change during September has been around 2.4% which stands to be the highest among all 12 months. The highest return during September has been 26% while the lowest has been -11.6%. During the same period the average change for DXY (Dollar Index) has been 0.2% during September with a maximum of 5.7% and a minimum of -3.7%. Moreover, during October the DXY has declined 0.6% on an average.
Source: Bloomberg
Key gold-demand driver’s during September:
• The post-monsoon wedding season in India and increased buying before one of the most important festivals of the country – Diwali.
• Restocking by jewelry makers in advance of the Christmas shopping season in the United States;
• The holy month of Ramadan in the Muslim world, whose end in late September is marked by a period of celebration and gift-giving;
• And in China, the week-long National Day celebration starting October 1 and the run-up to the Chinese New Year in early 2010.
Dollar seams to weaken against the Euro, Yen and the basket of other currencies as stocks and commodities such as oil, gold and silver keep rallying. The appetite for risk is eminent from the strong movement in the equity space and the sentiments towards the dollar being the safest of safe heavens turned weak. Any decline in dollar benefits the multinationals due to improvement in the corporate earnings which further leads to improvement in the overall economy. Since June end, dollar has declined 4% against the Euro & 5% against the Yen. This means that the earnings for the several US multinational companies might improve during Q3′09 adding to improved fundamentals.
Significance of the recent rally in the precious metals
Since 19 Aug’09, Silver has risen 22% while Gold has risen 7%. Is this move in these metals gives any direction to the equity markets? Yes! Definitely the move is significant and gives a direction to the equity markets as the strength in these metals might continue over the next few weeks. This move is suggestive of the positive movement in the equity markets as the dollar might remain week against the major currencies. History suggests a negative correlation between the dollar and equity markets, as can be seen in the below chart.
Source: Bloomberg
Bottom-line:
The dollar might correct 3-4% from the current levels suggesting a target of 74.2 for DXY. S&P is likely to move towards 1076 level making it a potent of 5% upside. On Gold the target is $1032 per ounce, another 4% from the current levels. Although the momentum is strong in Nifty, still it might be tough for it to cross the psychological level of 5000 during this move as the target for the index remains at 4970 another 6.6% form current levels. Target for Oil is $75/barrel and for Tadawul is 5842.
It is recommended to stay long on equities and commodities while one could even short the dollar for the above targets as an aggressive trade.
Posted by: Munish Rao
Investment Analyst, Bahrain Islamic Bank
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