The US Dollar Index (USDX) has been now bouncing back by more than 18% since the bottom posted at mid-July. This low level was identified as the second leg of a “double-bottom” pattern which is a strong basis for a rebound (see on the daily chart). This is what happened and now the Dollar Index has already retraced 23.6% of the long-term bearish trend started in July 2001 and ended then at mid-July 2008.

Click To Enlarge

This long-term bearish trend (between points A and B on the weekly chart) drove the Dollar Index roughly from 125 to 72 therefore a loss in value of more than 42%. On the medium-term, the target is likely to be the resistance line plot just below the 38.2% Fibonacci retracement. It’s a previous high level where a “double-top” occurred (points C and D) that generated the second phase of the bearish trend, between 2006 and July 2008.

On the short-term, let’s use a system based a on multi-dimension oscillator to anticipate the price action. We use the Chande Momentum Oscillator (CMO).

Click To Enlarge

The CMO can be used to measure several conditions.

Overbought/oversold: the primary method of interpreting the CMO is looking for extreme overbought and oversold conditions. As a general rule, overbought levels are quantified at +50 and the oversold levels at -50. At +50, up-day momentum is three times the down-day momentum. Likewise, at -50, down-day momentum is three times the up-day momentum. Basically, these levels correspond to the 70/30 levels on the RSI indicator.

Trendiness: the CMO can also be used to measure the degree to which a security is trending. The higher the CMO, the stronger the trend. Low values of the CMO show a security in a sideways trading range.

Divergence: as is often done with other momentum indicators, divergences occur when the indicator does not confirm new highs or new lows posted by the price action.

Other: although not specifically dedicated to patterns recognition, the CMO may be also used to identify chart formations, failure swings, and support/resistance levels.

If we establish overbought/oversold entry and exit rules by plotting a moving average trigger line on the CMO, therefore alerts are triggered when the CMO crosses its 9-period moving average after being in an overbought or oversold condition.

It’s a short-term basic system that typically well identifies inflexion points.

The recent fall in the value of the Australian Dollar, while painful for Australians looking to travel overseas, has proven popular with many traders whose trading accounts are denominated in US Dollars.

From a traveller’s perspective, every cent that the Australian Dollar falls means less spending money in their pockets when they convert their Australian Dollars into US Dollars.

However, the sharp falls have eased the pain of those traders watching their US Dollar accounts erode in value with the strengthening Australian Dollar.

Imagine you were a trader who wanted to trade options on the US market. You open an account with a US Broker in 2002 and send over $A10,000 to fund your account. With an exchange rate of 0.5000, you now have $US5,000 in your account.

Now imagine you are a conservative trader and over those 6 years you managed to double your trading account. Your trading account is now $US10,000.

Now you decide to bring the money back to Australia. However, it’s 2008, and the exchange rate is now 0.9800 (98 cents). Suddenly, you need 98 US cents just to buy 1 Australian Dollar, whereas six years ago, you only needed 50 US cents.

Now your $US10,000 – which was double your initial investment - is only worth $A10,204. Nearly all of your gains have been wiped out by the exchange rate fluctuations. Can you see the importance of managing your currency risk?

Chart 1 below shows the weekly bar chart of the Australian Dollar (FXADUS in ProfitSource)

Chart 1

click to enlarge

As you can see, it is not just Currency Traders who are faced with the risks associated with changes in the exchange rate. Of course, had the trader waited until October to bring their US Dollars back to Australia, the exchange rate would have been much more favourable for them.

Anyone with any exposure to overseas currencies, whether through their trading, their travel plans, or business transactions needs to manage their currency risk.

So how can we go about it?

The simplest way to lock in the exchange rate today is to open an FX trading account. Let’s say we have some US Dollars sitting in a bank account in the United States.

If the Australian Dollar rises in value, the US Dollars will fall in value, meaning less Australian Dollars should we decide to bring the money to Australia. To lock in the current exchange rate, we can open an FX hedge by opening a currency position.

In any FX transaction, we are always buying one currency, and selling a second currency.

So in this case we would open a position that would buy Australian Dollars, and sell enough US Dollars to cover the money in our US bank account.

As long as there is enough money in your FX trading account to cover the margin on the trade, you will be able to leave this hedge open until you are ready to bring your US Dollars back to Australia. If Australian interest rates are higher than US interest rates, you can even be paid interest on your position, in what is called a “carry trade”.

If you have US Dollar exposure and you don’t check the exchange rates very often, it can be a good idea to hedge your position and lock in your exchange rate, to remove the possibilities of any nasty surprises.

There are other methods for locking in an exchange rate using Forward Exchange Contracts and options, however that is a subject for another article.

If history is our teacher, it tells us that the dollar does respond to any crisis for a few months or so typically after the economy hits another rough patch. However, afterwards, it reverts back to the trend at hand.

If it went into the crisis in a downtrend, then it goes back into it again. And if it went into the crisis in an uptrend, then it tends to revert back to that uptrend too.

If history is any indication, then it’s very possible the dollar will simply continue the downtrend it’s been in for the past six years: crisis or no crisis.

But due to additional factors - namely the dollar being at a 30-year low point at the beginning of this predicament - I don’t think it’s going to be a very clear downtrend. At least not in the short-term.

I see the dollar ‘ranging’ (Forex speak for going nowhere at all) over the next few years, much like it did after the S&L crisis, as you can see below.

Bank Failures Mean the Bumpy Ride Will Continue

This is what I believe may happen this time as well. However, on a year-over-year basis, it won’t feel like a wide range. It will feel like very strong, sharp uptrends. It’s only when you look back on this era over 10-15 years that you may see the dollar ranged for several years after - what shall we call it? Perhaps - “The Bailout Crisis of 2008.”

The dollar has gained against global currencies since August 8, when Germany’s mighty economy contracted in the second quarter, triggering one of the biggest dollar rallies in years.

And maybe it was time for a rally. Since peaking more than six years ago versus the world’s major currencies, the U.S. dollar has posted some dizzying declines. Only a few currencies in the world have actually declined in value against the sad buck since late 2001…one of which being the Zimbabwe dollar.

But this current bout of dollar strength has more to do with the surprising weakness of other foreign economies than a resumption of U.S. growth. We’re simply ahead of the curve.

The market views the dollar as a leading currency as other economies begin to grapple with an economic slowdown or, in some cases, recession. The United States has already gone through the process of priming the economy with interest rate cuts and fiscal measures to boost consumption, driving the dollar lower in the process. Now it’s the turn of the Europeans and Japanese. They are only now starting to enter slowdowns in their economic cycles.

That means they’ll be cutting rates, so their currencies will weaken. And the value of their assets – in dollar terms – will decline.

Therefore, savvy investors in the next few months will look to build positions in some of the U.S. economy’s most beaten-down, oversold assets. Specifically, foreign and U.S. investors alike can find significant value and opportunity in distressed U.S. debt, real estate and stocks.

You can’t really make a long-term bullish case for the buck right now. Sure, the dollar has had a strong rally recently, but that doesn’t change the fundamentals. We’re still looking at no interest rate hikes, a fiscal deficit that continues to grow, and weak consumption, thanks to an historic credit squeeze and real estate deflation.

And yet the buck has been getting a lot of love since early August – rallying nearly 8% against a basket of major currencies. What gives? Do global investors see positive factors we don’t? Hardly. Overseas investors are simply taking advantage of cheap dollar-based assets and 2009 growth prospects for the U.S. economy that are more compelling than for other major economies.

In short, almost certainly, what we’re looking at right now is not a new dollar bull market, but a cyclical bear market rally. That’s exactly what happened in 2005 as the dollar rallied 12.8% versus the euro and other currencies. But back then the Fed was raising short-term interest rates and the U.S. economy was still firing on all cylinders.

It’s quite a different story now.

In fact, the only thing that could keep the dollar rally going is a continued deterioration of other major economies while U.S. growth accelerates.

This is pretty typical of professional traders. All the pros leave the FX market alone on holidays. In fact, my opinion is that the Forex market should post a sign that says “Enter at your own risk” during major U.S. holidays.

I say this because the Forex market is like a renegade switch on most holidays. The market is either “turned on” and your trades are moving like crazy (which means it’s hard to predict what will happen next). Or the market is completely “turned off,” and it’s about as interesting as watching paint dry.

More often than not, you’ll see BOTH scenarios happen on a single holiday. First the market will be switched on, and then it will suddenly switch off - or vice versa. Unfortunately, there’s never any telling which comes first…the “calm” or the “storm.”

So on any given holiday, I generally wait until the afternoon to check on the currency markets. Then I just wait for the “show” to start. Frankly, for a seasoned trader like myself, it’s fun to watch the markets move that fast.

But it’s definitely NOT time to start trading. Please keep that in mind for every holiday going forward.

According to the market it is a done deal, with interest rate futures pricing in at least a 0.25% cut, with a further 0.75% expected over the next twelve months.

The green line on the chart represents the level at which the market has priced in a 100% certainty for a 0.25% cut in the rate tomorrow. Currently the red line is above the green line at 116% which means there is a small expectation that the rate cut could be higher.

Therefore, expect the Aussie dollar to potentially rise a bit tomorrow if there is only a 0.25% cut, or fall quite a bit more if there is a 0.50% cut.

This is because the FX markets should have already factored in at least a 0.25% cut. If the RBA does nothing, well, a sharp rally in the AUD would be almost guaranteed.

The US Dollar ended the week with a sharp rally that confirmed the recent breakout and the base building that began following the March 2008 low of 70.70, analysis at the time suggested that the Dollar was heavily oversold and projected a target towards $78, which is now in reach following the USD Index close of 77.15 on Friday.

Last weeks continuing rally is taking the US Dollar into a short-term overbought state, especially as it nears resistance at 78, on break of which the US Dollar will target a move towards significant resistance at 80, following which the Dollar is expected to consolidate, with the previous resistance levels turning into support levels i.e. Major support at 74.30 and 78, before the next leg up through resistance above 80 takes place towards a longer-term target for the dollar of 90.

Whether or not the Dollar has seen its final low that brings to an end the 7 year long bear market, what the recent price action does signal is that the US Dollar is now in a bull market that looks set to run for at least a year, by which time the longer term trend will become more apparent, in that respect the bullish dollar trend is expected to continue into at least early 2009, which confirms analysis as early as of March 2008 that concluded that the commodities markets would enter into a bear market during the summer of 2008 that would last for at least 1 year and possibly as long as 2 years.

While gold prices are likely to decline further in this correction, gold mining stocks have already been pounded much harder. That makes some of the best mines in the business highly attractive at these low levels.

One important indicator I track now suggests a massive rally lies ahead for distressed gold stocks. 

Since 1974, the Gold-XAU ratio has been greater than 5.0 for about 15% of the period.

The XAU Index or Philadelphia Gold & Silver Index is a composite of leading gold and silver mining companies. Most of the stocks in this index are large-cap gold shares.

When the Gold-XAU ratio has been 5.0 or more, like now (currently at a whopping 6.02), the XAU Index has recovered with an annualized gain of 89.6%.

When the ratio has been 4.0 or higher, the XAU Index has rallied an average 27.4%. But when the XAU has traded at 3.0 or less, the index has declined an average -36.6%.

The Last Time This Chart Looked Like This Gold Rallied Over 280%

This chart above is quite mind-blowing if you’re a Gold-Bug. Basically it strongly points to a major up-crash for gold stocks. No one can say exactly when this will happen but it’s safe to say speculators will earn a bundle once it bottoms.

The current Gold-XAU ratio is an extreme 6.02 as of August 7 and at 5.99 as of August 11. The last time this ratio stood north of 6.0 was back in 2001. Seven years gold stocks soared more than 280%.

For now, the U.S. dollar rally still has legs and gold along with most commodities will probably continue to decline.

The buck has been badly oversold for months. Now the greenback is embarking on a secular bear market rally. But without higher interest rates to support the buck, balanced budgets or a rapid return to above-trend economic growth, there is absolutely no reason for the dollar to sustain this rally beyond a few months.

The United States will not escape an economic recession, possibly a hard recession. The contraction of credit combined with deflationary forces still plaguing the housing industry are events that won’t disappear with a minor housing rescue package or a government spending bill.

The real threat to the United States is deflation, not inflation. This threat to consumption will likely lead to below trend growth for at least another six to 12 months.

The dollar’s rally won’t last forever. Don’t abandon gold.     

Dollar Rally Won’t Last Forever

Fundamentally, there is nothing to support a long-term U.S. dollar rally. 

Unlike 1995 when the dollar established a secular bear market low against major currencies, this uptrend will inevitably run out of gas.

Bear market rallies appear quite convincing and can muster significant strength over a short period of time. But this one simply has no long-term muscle.

Let me explain. In the late 1990s, the United States posted consecutive budget surpluses, enjoyed massive foreign direct inflows and low consumer prices in an environment of accelerated disinflation. No major military conflicts occurred and oil prices crashed to US$10 a barrel by late 1998 amid the Asian economic crisis and the collapse of hedge fund Long Term Capital Management.

Today’s U.S. and global macroeconomic scenario is nothing like it was 13 years ago.

Soaring deficits, two major military conflicts, a distressed consumer, rising unemployment and a bear market in housing won’t lend support to a secular dollar rally. In fact, Bill Gross, PIMCO’s bond king, predicts lower interest rates in the United States over the next several months as deflationary pressures continue to drain economic growth. Lower rates won’t support the dollar.

Remember the Credit Crunch?

The Fed is in no condition to raise borrowing costs despite high inflation. The ongoing credit crunch has not abated with overnight borrowing costs still elevated and mortgage-backed securities still clogged.

Over the last 30 days the stock market is up almost 8% but most credit indices remain at the same level or lower ever since Treasury Secretary Paulson guaranteed Fannie Mae and Freddie Mac wouldn’t fail.

That tells me credit markets are still far from stable as the economy remains fractured across key industries like housing, retail, autos, and airlines.

The big news this past week was definitely the dollar. The dollar rallied the most against the euro than it has in the past eight years. The dollar index climbed the highest it has been in six months.

So the question is: What’s going on here? How can the dollar rally like this when the greenback’s fundamentals leave so much to be desired?

Let me give you my theory about what’s happening here. To really understand it, you need to start with a question:

What happened to decoupling, the idea that other economies are immune to the United States’ weakness?

Well, it seems the sub-prime fiasco created bigger problems for the U.S. financial system than everyone thought. And now we’re seeing this economic virus spread to other areas of the globe.

Need Evidence? It’s All on the Nightly News

It’s pretty easy to see other countries are feeling our same sub-prime pain. Just look at these recent news stories…

• German industrial orders dropped sharply - by 2.9% in June. That’s disconcerting considering Germany’s economy makes up one-third of total Eurozone output. And speaking of the rest of the Eurozone, many of those economies are bogged down by housing busts just like us.

• The International Monetary Fund (IMF) called out the U.K. economy. They predicted the U.K. would grow 1.8% and 1.7% for 2008 and 2009, respectively. All I have to say is: Kiss those numbers goodbye. The IMF’s latest forecast calls for a seriously lower 1.4% in 2008 and 1.1% in 2009.

• Australia is battling sluggish household spending and their financial sector is being challenged. The National Bank of Australia recently reported a huge second quarter write-down, which they blamed on massive collateralized debt obligations (CDOs).

• And the New Zealand Treasury anticipates a second consecutive quarter of negative GDP growth. By definition, New Zealand will have entered recession once official numbers are released. They’d be the second OECD-member country since Denmark to sink to official recessionary status.

The reality is that the big three in the developed world - the U.S. the U.K., and the Eurozone - are staring into the face of recession.

How Does this Big 3 Recession Affect the Next “Superpower?”

As we were so often told when analysts were pushing the decoupling theory, China is set to take over the world.

But if weakness is spreading around the globe, what does that mean for China?

The 2008 Summer Olympics are just now beginning, and there’s news that pollution has grown to far worse levels over the last few months. Chinese officials are putting all kinds of limits on how many cars can be on the road on any given day.

Additionally, in an effort to minimize excessive air pollution, Beijing is closing 105 factories. And should conditions worsen, neighboring cities could close as many as 117 factories combined.

Anticipation of the games gave Chinese companies reason to ramp up production. But what’s concerning is these companies front-loaded production and an inventory glut is building up.

It makes you wonder how much extra production was jammed into the last quarter in order to prepare for air cleansing before the great games began.

I suspect plenty.

That’s never good because they will have to sacrifice growth for as long as it takes to work through the oversupply.

As you can plainly see, some commodity bulls are back-peddling this year. We know from our hedge fund experience that the falling US dollar played a big part in rising commodity prices.

Which isn’t to say that real commodity demand doesn’t mean anything. But if you plan to have anything to do with cheap resource stocks, you need to consider the US dollar’s direction. Today we’ll do it for you. Here’s the Euro/Dollar Chart.

Currencies can get confusing. So just remember what this chart shows: how many US dollars you can buy with one Euro. Not the other way around. When the price here rises, it’s the Euro rising. Not the dollar.

The key point fundamentally is the future interest rate differential between the US and Europe. At the moment traders are leaning towards rising US rates and falling European rates. That, more than likely, will mean a short term uptrend in the US dollar. That would mean a falling Euro.

You can see that the chart agrees, reader.

The MACD is clearly bearish. The technical Momentum indicator has also crossed below its signal line at 100. The bearish momentum is building up. There’s a long way to go before you can call the Euro oversold.

The next support for the currency pair is 1.53. It’s been tested several times in the past few months (points A, B and C on the chart). But personally, we’ve got our binoculars firmly trained on 1.50. It was a famous previous high (points D, E and F).

* Dollar rises against yen after U.S. durable goods

* Housing, sentiment data to come

* Oil recovery, equities remain in focus (Adds comments, byline, updates prices)

By Wanfeng Zhou

NEW YORK, July 25 (Reuters) - The dollar rose against the yen on Friday after a government report showing an unexpected rise in durable goods orders eased worries over the U.S. economy.

The solid reading lifted sentiment on stocks and spurred a recovery in risk appetite, putting pressure on the low-yielding yen. The dollar also pared some of its losses against the euro.

Durable goods orders were up 0.8 percent in June, after a revised 0.1 percent gain in May, the Commerce Department said on Friday. When volatile transportation orders were excluded, orders climbed 2 percent last month, the sharpest rise since December. For details, see [ID:nN24332112].

“All in all, a strong piece of data for the U.S., in contrast with fresh signs of weakness in Europe and the UK,” said Brian Dolan, chief currency strategist at Forex.com in Bedminster, New Jersey. “I think stocks will like it, yen crosses will too, and the dollar also.”

In early trading in New York, the dollar rose 0.3 percent to 107.72 yen

The euro traded 0.2 percent higher at $1.5700 <EUR=>, still roughly 3 U.S. cents below a record high set in mid-July.

The euro also jumped 0.5 percent to 169.05 yen <EURJPY=>.

MORE U.S. HOUSING, CONSUMER DATA

Despite getting a boost from the much-stronger-than-expected durable goods orders data, sentiment on the greenback remained cautious as market participants awaited more U.S. data later in the day, including new home sales for June and a consumer sentiment poll for July.

Against a basket of six major currencies, the dollar remained 0.2 percent lower at 72.791, retreating from Thursday’s two-week high .DXY.

The Commerce Department’s housing data will be closely watched after disappointing news on existing home sales released on Thursday sent the dollar down sharply against the yen.

But some analysts said that the scope for weak U.S. data to hurt the dollar was limited as a fairly negative U.S. picture is already priced in, and euro zone economic data has also been coming in on the weak side.

“The expectations are for lower readings across the board, but the impact of FX trade may depend on the degree of the decline,” Boris Schlossberg, senior currency strategist at DailyFX.com, said in a research note.

“With markets already so preconditioned to bad economic news from the U.S., the greenback may not weaken much further unless the data shows substantial deterioration from the prior month.”

The euro edged higher on Friday despite figures showing a slowdown in money supply growth [ID:nFAE002362].

The single currency hit a two-week low against the dollar on Thursday after data showed German business sentiment suffered its biggest drop since September 2001, while euro zone PMIs pointed to contraction in both the services and manufacturing sectors. (Additional reporting by Gertrude Chavez-Dreyfuss in New York and Naomi Tajitsu in London, Editing by Jonathan Oatis)

* U.S. consumer sentiment rebounds from 28-year low

* Durable goods, housing top consensus

* Oil prices, equities remain in focus (Recasts; updates prices, changes byline)

By Vivianne Rodrigues

NEW YORK, July 25 (Reuters) - The U.S. dollar rose against the Japanese yen on Friday, after a trio of better-than-expected data injected a dose of optimism aboutthe U.S. economy.

The upbeat readings on U.S. durable goods orders, new-home sales, and a rebound in consumer sentiment from a 28-year low allayed some of the recent gloom over the economy and financial markets, sending stocks higher and giving a boost to the beleaguered U.S. currency.

“This is perhaps the best we could have ever hoped for amid the current economic conditions,” said Michael Woolfolk, senior currency strategist at The Bank of New York Mellon in New York.

“It flies in the face of the pessimists out there calling for a recession. It’s just simply not reflected in the numbers,” he added. “The dollar rally gets a strong green light to continue buying.”

In late trading in New York, the dollar rose 0.5 percent to 107.87 yen <JPY=>, after climbing as high as 107.94 yen, slightly below a one-month high of 107.98 yen set on Thursday, according to Reuters data. 

The euro traded 0.1 percent higher at $1.5693 <EUR=>, roughly 3.0 cents below a record high set in mid-July.

Against the yen, the euro jumped 0.6 percent to 169.34 yen <EURJPY=>.

But on the New York Board of Trade’s U.S. dollar index .DXY of major currencies the U.S. dollar remains trapped in its range of the past four months, after seeing a big slide last year.

U.S. durable goods orders were up 0.8 percent in June, after a revised 0.1 percent gain in May, the Commerce Department said Friday. For details, see [ID:nN24332112]

Separate data showed sales of new homes in the United States fell to a 530,000 annual pace last month, against market expectations for a drop to a 500,000 rate, while consumer sentiment recovered unexpectedly in July after falling in June to the lowest level since the early 1980s. [ID:nN25494864] [ID:nN25487506]

OIL, EQUITIES IN FOCUS

Gains in U.S. equities and a continued drop in oil prices to a seven-week low on Friday further lifted sentiment toward the dollar. U.S. crude futures last traded down 1.7 percent, at $123.37 a barrel.

“We are really seeing a couple of different factors shape up: oil dropping, equities rally and clearly the good data, which should support at least a minimum dollar rally to yesterday’s lows (on euro/dollar),” said Greg Salvaggio, vice president of trading at Tempus Consulting.

More good news on the mortgage sector added to dollar strength. The U.S. Senate voted on Friday to limit debate on a bill aimed at shoring up both the housing market and mortgage finance companies Fannie Mae (FNM.N: Quote, Profile, Research, Stock Buzz) and Freddie Mac (FRE.N: Quote, Profile, Research, Stock Buzz), paving the way for a final vote that is expected on Saturday.

But some analysts cautioned that the impact on the dollar from Friday’s positive data may be limited.

“The follow-through will be distinctly limited,” said Alan Ruskin, chief international strategist at RBS Global Banking and Markets, in a research note.

“The next real lead on the economy comes from the ISM numbers, and by far the most important data — nonfarm payrolls — in a week,” he said.

The euro hit a two-week low versus the dollar on Thursday after data showed German business sentiment suffered its biggest drop since September 2001, while euro zone PMIs pointed to contraction in both the services and manufacturing sectors. (Additional reporting by Wanfeng Zhou and Lucia Mutikani in New York)