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Investors this past March reminded me of those San Fermín festival attendees in Pamplona, Spain, running for their lives from gigantic, furious male cattle...
In the span of two months, the United States dollar went from the most coveted asset in the world... to one of the most dangerous to hold in bulk.
Over the weekend, Goldman Sachs Group Inc. (NYSE: GS) released a note revealing that it is betting against the U.S. dollar. The investment bank anticipates even more investors will rush into the stock market as the U.S. economy reopens.
It's not just the prospect of the flood back into equities that could lead to a drop in the U.S. dollar. The U.S. Federal Reserve and Congress' massive effort to provide liquidity to the economy has dramatically expanded the central bank's balance sheet and sent the U.S. debt levels to sky-high levels. The Fed effectively created $2.3 trillion out of thin air in April in an effort to spur loans to cities and small- and medium-sized businesses.
By the end of this crisis, the Fed's balance sheet could easily top $10 trillion.
In addition, growing unrest across America has fueled criticism of the United States and uncertainty about its standing in the world. The threat of another wave of coronavirus and increasing unrest across America could reduce the dollar's status as the world's reserve currency.
There are other threats to the dollar that continue to creep in, just under the radar.
China's recent security law regarding Hong Kong's status could upend the peg between the Hong Kong dollar and the U.S. dollar. Meanwhile, countries across the Middle East are again reconsidering their peg to the U.S. dollar following the recent price collapse of oil. Their peg to the dollar effectively forces these nations to price crude oil in dollars and drives demand for the U.S. currency. "De-pegging" from the dollar would reduce that demand. Both of these events would be significant and will likely trend as potential concerns in the years ahead.
And whether your investing style is aggressive, conservative, or somewhere in between, there are ways to profit...[mmpazkzone name="in-story" network="9794" site="307044" id="137008" type="4"]
Here Are the Moves to Make
Positioning yourself for a downturn in the U.S. dollar depends on risk tolerance and preference in assets. Non-interest-bearing assets like Bitcoin and gold have unique risk/reward propositions compared to exchange-traded funds (ETFs) and currency trades.
Money Morning Chief Investment Strategist Shah Gilani advocates that smart long-term investment to hedge against inflation: gold.
Shah recommends investors allocate about 5% of their portfolio in gold. This could be physical gold - bullion - or one of the few ETFs that are backed by physical metal, like the SPDR Gold Trust ETF (NYSEArca: GLD). GLD is one of the world's largest and most liquid ETFs in the world, and every share is backed by the real McCoy.
It tracks gold by holding physical bullion in a trust that is kept in an allocated account that holds 400-ounce London Good Delivery gold bars. This ETF has a tracking error of less than 1%, which means that it has a virtually ironclad correlation between its performance and the underlying movement in gold prices.
The long-term outlook for gold remains strong. Bank of America Corp. (NYSE: BAC) projected in April that gold could hit $3,000 over the next 18 months due to the COVID-19 pandemic and the expected economic impact.
At the same time, we can boost our profits "shorting" the dollar, with the Invesco DB USD Index Bearish ETF (NYSEArca: UDN). This fund tracks changes, both positive and negative, in the level of the Deutsche Bank Short USD Currency Portfolio Index. This tracks performance of the dollar against a basket of the six major world currencies - the euro, Japanese yen, British pound sterling, Canadian dollar, Swedish krona, and Swiss franc.
UDN recently bottomed out at roughly $19. Since its inception in 2007, UDN has never traded under that level for a sustained period. Indeed, the dollar has remained very strong against other foreign currencies over the last five years... which means the possibility of a reversal is increasing due to recent economic, political, and social events.
The natural risk for this move is that the U.S. dollar rises and demand for the U.S. dollar expands due to increased uncertainty in Europe, Asia, and emerging markets. However, the broad expansion of the U.S. debt combined with the dramatic effort by the Federal Reserve to expand its balance sheet, and the supply of dollars could be inflationary.
Here Are the Actions to Take Now
For the long term, take a 5% position in gold bullion or a gold-backed ETF like GLD.
For the short-term play on UDN, I like cash-secured puts and the purchase of a call option.
In this case, I'm specifically looking at the UDN Dec. 18, 2020 options chain. Right now, traders can put in a limit order to sell the $19 put with a limit order of $0.15 to $0.20 - obviously the higher the better.
Selling this put would mean that you are giving someone else a chance to sell you 100 shares of the UDN fund if the price falls under the $19 strike price.
In this case, a trader would want to lock in and purchase at that level and ride a weaker dollar over the long term. For this reason, you'd want to set aside $1,900 of speculative capital - enough to purchase 100 shares at the strike price - if you are filled on the price.
Keep in mind that if the UDN pushes higher, you will be able to purchase those puts back at a lower price and pocket the gains on this trade.
Meanwhile, weakness in the U.S. dollar would drive the UDN fund higher. So, we want to target the $22 call for the same month. In this case, you'd want to purchase these calls for $0.15 (the last price). You'll be selling the put and buying the call. If you're willing to take on a bit more risk, you could pair the $20 put with the $22 call, which are trading in similar price ranges.
What You Need to Know About Risk and Profit
A cash-secured put is by definition a conservative way to reduce risk tied to selling puts. Should the UDN fall to $18 over the next six months, the seller would effectively need to purchase 100 shares of the fund at $19 should the buyer execute the contract. This would mean that your position would be off $100 at the time of the execution. That said, the ability to buy into the UDN at $19 is a bargain given the weakening fundamentals for the U.S. dollar.
However, it's worth noting that even at the height of the recent COVID-19 crisis, the fund didn't breach the $19 level. With the Federal Reserve fully committed to providing liquidity to companies and the broader economy, the potential of another run to cash is really limited.
Should the UDN trade in a range between $19 and $22 over the next six months, the trade is effectively a wash. But if we see a sharp decline in the dollar, it could breach the levels it hit in 2018 when it traded above $23. If the UDN were to push to just $22.50, investors would double their return on the call and could pocket the gains from selling the put.
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About the Author
Garrett Baldwin is a globally recognized research economist, financial writer, consultant, and political risk analyst with decades of trading experience and degrees in economics, cybersecurity, and business from Johns Hopkins, Purdue, Indiana University, and Northwestern.