A Melman Minute — July 19, 2007

North American markets opened sharply higher this morning with the Dow Jones Industrials up over 80 points within just a few minutes. It therefore appears that once again the financial markets have succeeded in overlooking whatever might be the troubles-of-the-moment which afflicted them yesterday and are powering anew into record high territory. Both the DJI and the TSX are at all-time highs and appear poised to rally on to new heights.

However, it is our opinion that there are two doses of reality ‘out there’ that are waiting to put their negative stamp on financial markets and that their individual or combined effects cannot be postponed forever. We are referring to the collapse of the US Dollar and the threat of higher interest rates.

Let’s focus on the US Dollar. As has been noted many times, it is not ‘just another’ currency. It is the reserve currency of the world, meaning that it is the currency in which the reserves - or stored monetary values - of various nations are placed. In reality, during the past five decades, the U.S. Dollar has supplanted gold’s former position in this function among nations.

The U.S. Dollar is also the currency in which international trade is denominated. Crude oil is denominated in dollars. Gold and silver likewise. Same thing with copper, nickel, lead, zinc, corn, wheat, etc. In all these cases, the monetary conversation to establish international prices is United States Dollars. So, in fact, what happens to the greenback is of great importance - and what has been happening is a slow motion hemorrhage.

One look at the long-term U.S. Dollar Index chart tells a fascinating story. After years of relative strength, the U.S. Dollar Index (DX) peaked in 2001-2002 above 120, but it has been primarily downhill since then, with losses amounting to nearly 35%, losses which are inversely reflected in powerful rallies among such currencies as the Canadian Dollar, Australian Dollar, British Pound, Euro, Swiss Franc, etc. The chart of DX finally put in a bottom in 2005 near 80, then rallied into the low 90’s, but it is headed south once again and sits just a hair above 80 this morning.

This chart bears close watching. If the DX crashes below 80, it would appear that there could be a further severe loss of confidence in the American Dollar, one, in fact, which might result in a wholesale unloading of the American Dollar by foreigners with resultant turmoil as the world searched for an escape currency. Additionally, if the greenback began to fall rapidly, one of the only weapons politically available - besides curtailment of government expenditures and balancing of both the American trade and budgetary deficits - is the raising of interest rates to make holding dollars more attractive. However, should that happen, the construction industry would suffer, the housing crisis would be exacerbated and the consumer economy could collapse.

In other words, America would be caught between a ‘rock and a hard place’, namely, either endure inflation and chaos because of a currency collapse or defend the currency and watch the economy suffer.

Looking at the chart, it would appear that we will see decisive action in the Dollar Index in the near rather than the distant future. If DX breaks below 80 and sustains that break for several days, then hedge positions within the precious metals should be seriously considered.

DISCLAIMER

The information presented above is based on data which we believe to be from reliable sources, but the accuracy of which cannot be guaranteed. Any opinions or predictions contained herein are those of the editor and are likewise offered also for information purposes only.

← All A Melman Minute