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The Inflection Point: Why the U.S. Dollar is Ready to Rebound

[Editor's Note: Silver and gold skyrocketed for months, while the U.S. dollar plunged. Most investors expected those trends to continue. But Money Morning's Jack Barnes, a former hedge-fund manager, knew better. He warned of a looming reversal that would stand the global financial markets on end. In this new Money Morning series, "The Inflection Point," Barnes will examine the causes - and effects - of this unfolding reversal, and will show you how to profit.]

For most of the past year, anything involving the U.S. dollar has been what traders like to refer to as a "one-way trade."

And with good reason: Over the past year, the U.S. currency has traded in only one direction – down.

Indeed, during the period in question the dollar is down 8.3% against the British pound, 11.65% against European euro and 14.2% against the Japanese yen. On a year-over-year basis, the biggest gains against the dollar have been notched by the Australian dollar (20%) and the Swiss franc (26.7%).
The Inflection Point

This freefall by the greenback is part of the reason that gold and silver soared to new records and commodity prices have zoomed during the past year (before their decline in the past week).

But here's the thing: This nosedive by the dollar is ending – with a U-turn that's going to send the U.S. currency into a zooming climb.

Traders refer to this abrupt reversal-of-fortune pattern as an "inflection point."

And those traders recognize this about-face in the U.S. dollar for exactly what it is: A windfall profit opportunity for investors who understand just how to play it.

Anatomy of an "Inflection Point"

Since June, when it achieved its most recent peak, the U.S. dollar – as measured by the benchmark U.S. Dollar Index (DXY) – plunged more than 14%.

The greenback has rallied a bit in the early part of this month. But there are much bigger gains to come – the kind of gains associated with a true financial asset "inflection point."

To understand the about-face that we're about to experience, it's important to understand there were essentially five factors that tipped the greenback over into its nose-dive. Those factors included:

The Barnes File

  • A Debt-Intent Central Bank: A big part of the demise in the near-term value of the U.S. dollar was the continuation of a U.S. Federal Reserve monetary policy that caused the central bank's balance sheet to balloon from $850 billion in 2007 to a new all-time high of $2.669 trillion in April of this year. Indeed, the Fed's balance sheet grew by $340 billion during the last year alone.
  • A Debt-Addicted Federal Government: Global interest in the dollar was further diminished by a U.S. federal debt load that soared from $8.9 trillion on Aug.1, 2007 (when the first signs of distress really hit the financial markets) to $14.298 trillion just 3.7 years later.
  • A New Market Rival: Thanks to some market machinations by China's government -which has caused that country's yuan (renminbi) currency to rise slowly against the U.S. dollar while dropping against China's other trading partners – the U.S. currency has grown progressively weaker. This has been driven by Chinese interventions in the so-called "FX" (foreign-exchange) markets on an almost-daily basis.
  • A Global Leadership Vacuum From Washington: It's a sad-but-true fact that the United States no longer commands the respect that it once did on the world stage. And much of that is the fault of Washington, which has lost touch with what's important both here at home and abroad. This lack of respect has helped diminish the "reserve status" of the U.S. dollar, leading to a bit of a run on the American currency.
  • The ‘Mortage-Backed Securities" on the Fed's Balance Sheet Fueled the Real Dollar Collapse: That real dollar collapse arrived as the implications of the Fed's monetization of MBS holdings hit home. In simple terms, people around the world have felt that America's central bank was debasing its own currency with the purchases of mortgage-backed securities (MBS) from U.S. banks that had been left holding the bag for some horrid trades. The Fed handed those bankers freshly minted U.S. Treasury bonds.

With each of these preceding five factors at work, it's little wonder that the United States was essentially debasing its own currency – leaving the leaders of other countries to watch as they scratched their heads in rueful disbelief.

In reality, Wall Street has been able to talk Washington into just about anything it needed – even though most of these schemes robbed Main Street consumers of their middle-class buying power. The obvious debasement of the American currency reached the point internationally that investors wanted to own anything but the U.S. dollar.

The accompanying graphic illustrates how investors have abandoned the dollar as they fled into other asset classes over the past year.

U.S. Dollar (1-Year Relative Performance)

You only have to look at the results for a few seconds to see that the reserve status of the U.S. dollar was being abrogated. It didn't hit the lows it reached during the depths of the global financial crisis but it got darned close.

Now, however, the inflection point is upon us.

Time For a Trend Reversal?

The reality of a "one-way" trade opportunity – which underscores the sharpness of an "inflection point" – is that they persist until they don't. I think of this as the "inflection moment," the point at which investors realize that they've ridden the trade as far as they can, meaning it's time to cash out and book their profits.

This is usually represented by a giant shift in investor sentiment. In the case of the U.S. dollar, it was the monetization of our national debt – to fund the deficit spending of the last two administrations – that destroyed the trust in the U.S. dollar. This single action, once boiled down, has carved off the U.S. dollar's buying power.

But now – with the dollar at a potential inflection point – should the Fed shift away from its currency-debasing policy, this could well prove to be the market bottom. That means the greenback will build on the early rebound move that we've already seen. Markets bottom when selling pressure abates.

At some point, the net selling pressure will abate as sellers run out of ammo, and the market switches to net buying pressure. It doesn't matter if it is FX, commodities, stocks or bonds. At the margin, trading is where real price discovery happens.

You can see the different signs showing up in different places, if you know where to look.

Five Inflection-Point Signals

During my time as a hedge-fund manager, I discovered five indicators that, taken together, provide a pretty reliable signal that a dollar reversal – an inflection point – is at hand.

When viewed individually, these indicators aren't that significant. But when they all shift at once, it's a pretty powerful hint that a new trend is afoot – and that windfall-profit opportunities are there for the taking.

To anticipate a reversal in the current decline of the dollar, you should:

  • Follow the U.S. Dollar Index (DXY): Despite its travails, the greenback remains the world's most-reliable reserve currency, which also makes it one of the very best indicators of raw market sentiment. If the index (as a proxy for the actual currency) establishes a bottom, you can bet change is afoot.
  • Watch Commodity Exchange Margin Requirements: As volatility increases, something we normally see in advance of an "inflection point," exchanges will rein in risk by increasing margin requirements. As we've seen with silver – a commodity that stumbled after margin increases in recent weeks – these shifts in the regulations can have quite an impact on speculation and on prices – dampening both.
  • Follow the (Big) Money: Pacific Investment Management Co. LLC's Bill Gross is the largest bond-fund manager in the world. Gross' buying or selling can get a market moving in a new direction quite easily. So when he opted to dump all his U.S. Treasury bonds recently, investors took note.
  • Never Forget the Fed: When the U.S. Federal Reserve needs to change its direction, it will send out a plethora of independent Federal Reserve presidents, or governors, to reshape market expectations.
  • Watch Dollar-Denominated Assets: The capital markets can be boiled down into a couple of major asset classes, which will trade either with – or against – one another. The U.S. dollar is the single-best example of this. Commodities are priced in dollars.

So let's look at each of these five in a bit more detail:

  • The Dollar Index: When the dollar does start to strengthen, it will unfold over a period of months, giving you plenty of time to make your move. Commodities will be directly affected: As the dollar increases in value, the cost to purchase them should start to shrink. If you are an investor with a long-term outlook, a lot of damage can be done to your portfolio while you wait for the next commodity-bull-market-move to return.
  • Commodity Margin Requirements: The Chicago Mercantile Exchange (Nasdaq: CME) changed margin rates on silver futures 10 times in the last six months or so. In early November, the CME Group's Comex Division permitted a leverage level ratio of 28-to-1 on futures contracts already held. Today, after five margin increases in silver in the last two weeks, the CME is now offering leverage of about 8-to-1. In my field, this is called "leverage compression," and it was likely one of the primary reasons that silver topped the way that it did – "spiking" up, and then down.
  • Big Money Moves: PIMCO's Gross is in a unique position. He manages the world's largest bond fund, which has morphed into the world's largest mutual fund. The so-called "King of Bonds," as he was known during the "Great Bond Rally of 1983-2010," is now out of U.S. Treasuries. This is a "screaming Buy" alert to anyone who pays attention to the "big picture" in terms of top-down investing. In fact, at the end of April, the PIMCO Total Return A Fund (MUTF: PTTAX), was 4% short on U.S. Treasuries via swaps in that "world's largest bond mutual fund," according to Reuters. This extreme change in sentiment is a tacit illustration of his expectations for the direction of the U.S. Treasury yield curve over the near-term to medium-term time horizon. Historically, Gross has been great at calling inflection points in the market. The only way his trade will make sense is if the U.S. Federal Reserve makes a surprise quarter-point increase in the benchmark Federal Funds rate – which would set the stage for a long-term series of rate increases in the future. While 25 basis points is insignificant in the big picture, it is a major change in sentiment and one that would have serious implications for the future structure of the U.S. bond market.
  • Never Forget the Fed: When the central bank decides to change its stance, markets will move. While hawks on the policymaking Federal Open Market Committee (FOMC) have started to sound off about a stronger U.S. dollar, this group lacks the votes, which has kept the market from fearing their comments. If and/or when the sentiment within the FOMC changes to favor an increase in rates (or even a "bias" in that direction), then all market biases will change. If you want an example, the best one to review is one from 1994, and the steady state of small, incremental increases that the market endured during the period. Stock prices were challenged, and bond values were hammered.
  • Watch Dollar-Denominated Assets: If the dollar is in a downward-trading pattern, there is little reason to fear that your long commodity positions will be hurt. If the U.S. dollar changes direction, you can expect that the longer-term commodity-price trends will experience a change, too. That may not happen overnight. But "at the margin" all commodities are a "short" U.S. dollar trade, meaning they represent a bet against a rising dollar. In other words, if I am leveraged long gold, I am realistically making a leveraged short U.S. dollar trade.

Moves to Make Now

Now that we know what to look for, it's time to talk about how to profit – at least in a general sense. (Future stories in this Money Morning series, "The Inflection Point," will provide many specific dollar-rebound profit plays to help readers navigate this tricky stretch.) But for you to understand what we'll be talking about, you need an overview of the kinds of profit plays we'll be looking for and talking about.

When the U.S. dollar bottoms, you can expect to see commodities pull back in price. You can expect to see margins expand in businesses that consume high levels of raw commodities. International shipping companies should see their profit margins improve.

Investors, companies and governments around the world use U.S. dollars as their "reverse" currency. When the dollar changes direction, it impacts the economy of the whole world. In the near future, having reached this "inflection point," the dollar will change its bias direction. And when it does so, every investment or investment strategy that used to work in the global financial markets, no longer will.

Now is the time to prepare your portfolio to the coming change in bias – the inflection point. You'll be glad that you did.

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  1. Mike Bernatz | May 10, 2011


    I have faithfully followed you and the money morning team steadily investing in a diverse group of commodities and commodity based ETF's. This article seems to directly contradict you and your teams bullish outlook on commodities. Have I misinterpreted this? Also, we are all anxiously waiting your Silver Wheaton (SLW) update!

    Forever Bullish,

  2. Werner | May 10, 2011

    Thank you for mentioning those points to watch out for.
    However, there is a big if,
    – if the Fed were to reverse its stance on interest rates, the stock market will crash, and the "wealth effect" Bernanke wanted to entertain will disapear.
    And another point is the US's fiscal policy and debtor status, which brings so many potential Dollar sellers all over the world. I have not played the Dollar short for months, if not years, but did not trade it long either. I just know of a lot of investors abroad holding lots of Dollar investments, unhedged, and who will only be too glad to get out unharmed.
    If the Dollar were to go up it will most certainly be a very bumby road, at least as long as the country's financial situation does not improve. And that, by the look of things, wont happen for quite a while! I have traded the Dollar rougly since 1971 against European currencies, whnever it got too strong, notably in 1985 the US asked for intervention to bring it down. Similarly the US supported the Euro in 2001 when it was at 0.8250. Inflection point may be there, but how long will it last?

  3. JPSerino | May 10, 2011

    So, I guess the fundamentals of the Fed printing "free" money that they "loan" to the banks, who then "loan" it to we the people at a profit, is the way to create real wealth? Well, then, in that case, why not print another $100 trillion? It would be nice if we the people were the benefactors, and not the debtors who keep getting the bill, holding the bag of fake money. Sorry, but you have it all wrong, unless you are one of "the big players", who are metaphorically telling we the people to "eat cake". It didn't work out so well for the French aristocracy in 1794, now did it?

  4. Guenther Sigel | May 10, 2011

    I hink also in this direction, because the Euro is more or less broken, the
    new reserve currency with a basquet of currencies around the Renimbi
    isn' full in action and China has too many $ bonds and so, Japan either,
    most etF's are ´$ nominated ETF's,raw maerials inclusive commodities
    he same, so ´the $ maybe longterm broke due o he high gov. debts,
    but now he $ has a potential to rise upwards until a new crirical pointg
    downwards comes in actiion.

  5. Jeff Pluim | May 10, 2011

    Mr. Barnes, you only give one reason for this supposed rebound of the USD, and that is a possible change in the Fed's monetary policy. Everything else that you talk about is supposed "signs" that the rebound is going to happen. Where are the facts that show that fundamentals are changed or are changing?
    I'm not buying your position. The fundamental weaknesses are overwhelming and there is no, or little change in them. The government is still operating in a fantasy world of their own. They believe (apparently as do you) that because the USD has never failed in the past, it won't fail now. It reminds me of the stupid people who had not seen a tsunami before. When the tide went out prior to the big waves coming in, they went and played on the beach instead of heading for higher ground. Because they had not seen it happen before, they did not think it was possible to get wiped out by the forthcoming tsunami.

  6. al robison | May 10, 2011

    Evidentally someone has kicked some sand in Barnes' computor.

  7. Kevin Postel | May 10, 2011

    I understand the Iraqi Dinar (IQD) is about to be revalued (RV) and save the day for many countries including USA. Is there any truth to any of this speculation?

  8. Gordan Finch | May 10, 2011

    Greece’s unpayable debt is dismantling the Euro as a single currency; Germany is unlikely to fund its failure again and other countries will cotton on. Greece has substantial Real Estate the IMF should consider a sale of some of its islands a realistic solution to Greece’s debt. However how is it so many countries have such huge debts; some readers will know the failure of the financial markets was down to one company AIG a subsidiary of Zurich Financials Services? This company’s fraudulent activity destroyed the wealth of millions of individuals; thousands of banks companies and most countries debts are the result of the failure of ZURICH FINANCIAL SERVICES.

    Now majority owned by the US GOVERNMENT who bailed it out with hundreds of €Billions. Zurich Financial Services are a continuing menace to the Dollar and stability of the Euro the European Union and World financial markets. Hopefully the US will break up this evil myriad hydra of deception and fraud, after its paid back the bailout €billions it owes. Gordan finch

  9. fallingman | May 10, 2011

    Ah yes, the contrarian view seems to have become the consensus view overnight.

    The dollar should bounce. That seems obvious. According to you, it's a given.

    The question is, will it?

    We'll see. Maybe it will.

    Maybe it won't. How come it hasn't already? The catalysts are all there…and yet, all that it's done so far is wobble higher from a deeply oversold condition.

    Maybe it's terminal and that's become obvious, so the bounces will be just that…bounces.

  10. Jim Freeman | May 10, 2011

    good article

  11. King Ralph | May 10, 2011


  12. Bob | May 10, 2011

    Inflection point? Maybe after the craziest of all Fed Reserve policies known euphamistically as QE2 ends but not before. On top of this you have possibly the stupidest Fed Reserve Chairman in history who will not raise interest rates this year. Can there be anything more stupid than undermining the international confidence in the U.S.$ by monetizing the national debt. He has preferred to irresponsibly roll the dice with the nation's long term structural well being pursuing policies that have consistently failed in the past. I would say send him back to academia but would not wish him on any student. The reason Bill Gross is shorting Treasuries is not in anticipation of any increase in interest rates by this stupid Chairman but in anticipation of the market demanding higher interest rates on Treasuries in the absence of the Fed purchasing them after the end of QE2.

  13. Terry | May 11, 2011

    This is a very valuable piece of information especially for our readers who are usually Asians having immigrated to Canada. Such immigrants usually send part of their earnings back home and due to weak dollar, the real value of their earnings has plunged in recent times.

    Allow me to reproduce a part of this article on the website and our readers would be benefited by your research

  14. Jim | May 11, 2011

    You are a bigger dreamer than all the boys and girls in Washington DC. who think they can turn up the speed of the printing presses and print our way out of debt. Our level of debt is not sustainable and our currency is going to tank. The only true MONEY is silver and gold. I am surprised that you would even dream up or print such a far fetched article as this.

  15. Duane | May 11, 2011

    Apparently you never read " The Next Commodities Bubble…It's Coming Sooner Than You Think" by Keith Fitz-Gerald, chief investment strategist for Money Morning. I sure wish all you financial experts from the same company would get their ducks in a row. It can't happen your way and his way at the same time. Is the sky falling or are we going to keep living in this economic bliss that our wonderful politicians have created? Your pill is very hard to swallow, I'm sorry but I feel you are sadly misled and mistaken in your beliefs.

  16. Alan | May 11, 2011

    You may get a bounce because of the pressure on the euro.
    Nothing has changed for the dollar.
    We have trillion plus deficits for as far as the eyes can see. Even if Washington went along with the Ryan plan we will have hugh decifits.
    The Fed will not increase interest rates any time soon. It will take down the stock market & to the powers that means more than thw health of the country.
    Commodity margins do not drive the spot prices in the long run.

  17. William Patalon III | May 13, 2011

    Greetings folks:

    Jack saw your comments, greatly appreciated them, and asked me to post his reponse.

    Thanks so much for taking the time to write….

    William Patalon III
    Executive Editor
    Money Morning

    Dear Readers:

    Thanks for your comments and for your questions.

    The U.S. Dollar Index (DXY) had/has bottomed at 72 and change, with a sudden and quick move up to 76 today (Friday).

    It is my opinion that as the commodity trade rolls over, that we could see a U.S. dollar in the 80 range by mid-July. This would be the exact opposite of what the talking heads and media pundits were calling for just days ago.

    You see, when everyone – and I mean everyone – in the market “knows” something, you can safely bet against it.

    It’s an example of the so-called “herd mentality” that we see at work in the financial markets. If “everyone” likes something, you will reach the point where there are just no more marginable buyers. At that point, you have basically saturated the pool; even though everyone loves the idea, there is no more buying pressure – and not even the potential for more.

    What there will be, though, is selling pressure – since people have to eventually make adjustments to their position. The only question that actually remains is: When will that (those adjustments) occur?

    The same thing happened with the U.S. dollar. But it happened in reverse. Everyone hated the greenback. Everyone knew to sell it. Everyone got on the same side of the trade, and that meant that the U.S. dollar had to go up, because the selling pressure ran out of ammo.

    There are those who make money following the herd into the shearing pens. And then there are those who make great money betting against the herd mentality. In the latter example, I mean that this group of investors waits until it’s time to shear the sheep – and then they bet against the group move.

    Which group are you in?

    That’s an important question to answer – and is an important bit of knowledge to have and understand – as you go about formatting (and then executing) your own long-term investing strategies.

    Stay tuned …. There’s more to come in our “Inflection Point” investing series.

    Also, if you’ve been following my coverage of silver over the past few months, you’ll want to check out Monday’s “Buy, Sell or Hold” column, when the promised update on Silver Wheaton Corp. (NYSE: SLW) is to run.

    Thanks so much!

    Jack H. Barnes Jr.

  18. Jenifer H | May 15, 2011

    I live in the euro zone (France) though my source of revenue is in dollars. As a 'local' I can tell you the euro is trembling and we could see a rapid domino effect following Greece, Ireland and Portugal. However, Europe is not the US, things don't just turn around overnight. These cultures are slow to initiate, slower to retract. Though this is a personal opinion and I'm not a financial analyst, I think we'll be seeing the euro around for decades to come.

  19. Ivan | May 15, 2011

    Yeah right

  20. TH | May 15, 2011

    Another fake move by the USD, need higher lows for the next couple of months to change the trend. Let me guess, fundamentals improving, yeah right. Doesn't QE2 stop soon, then what?

  21. Ken Peterson | May 18, 2011

    Currencies BACKED by precious metals will be those that survive. All others will either be re-denominated or completely destroyed. Paper notes without backing are just that, PAPER. The Federal Reserve is a PRIVATE BANK that the American people must bow to through OUR U.S. Treasury. The Reserve simply creates it out of thin air. OUR U.S. government (by the people) must stop kissing the feet of the Reserve.

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