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Betting against the U.S. dollar

The Stock: PowerShares DB U.S. Dollar Index Bearish Fund ETF

Recent price: $26.34

Trend: History may well show that structural cracks in the post-war global economic framework are the biggest challenge facing a generation of new investors now struggling amid the aftermath of a financial meltdown. Against that backdrop, the plight of the U.S. dollar is likely to play a key role in the drama ahead.

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The dollar story, however, will prove hard to follow.

Although the greenback, prior to 2008, had been in a long-term drift downward, the recent financial crisis and subsequent European debt woes revealed that absent a viable alternative reserve currency, heightened risk in global markets delivers international capital back to U.S. assets - propping up the American currency.

Of course, serious pessimists about monetary stability can be found in the gold bullion supporters' camp. Indeed, hard commodity assets in general are coveted in times of monetary instability. But currency volatility creates a very fertile ground for traders looking to capitalize on short-term shifts in exchange rates as capital markets navigate structural economic shifts. Not surprisingly, forex is, by far, the most liquid and actively traded market.

Equity investors also must be aware of how exchange rate risk affects their holdings - how they stand to benefit or suffer in a world of currency volatility. Shareholders of many multinational companies should be well-versed in this risk. Investors in commodity sectors are also tuned into currency instability that fuels capital flows in asset classes. While forex trading may be inadvisable to many - perhaps most - investors, other active equity traders can directly trade the greenback story by riding short-term trends in exchange traded currency funds.

The Trade: The U.S. Dollar Index measures the value of the greenback against a basket of foreign currencies, although it is predominantly weighted in the euro. Because of the specific makeup of the currency basket, the index is not a practical hedging instrument for real economic interests with trade flow risks. However, trading in the index's derivatives does represent speculative interest in moves in the greenback's value. The PowerShares DB U.S. Dollar Index Bullish and PowerShares DB U.S. Dollar Index Bearish exchange traded funds represent the performance results of long and short futures trading strategies of the dollar against the index components.

Like its underlying index, the PowerShares DB U.S. Dollar Index Bullish fund has been dropping for the past two months and is in a Stock Trends Weak Bullish category, a sign of the change in trend. The risk premium enjoyed by the greenback through the euro debt crisis has slipped away and the currency's relative value now reflects a return to equilibrium and softness in the U.S. economy. Investors looking to capitalize on this move can short the index by buying units of the PowerShares DB U.S. Dollar Index Bearish fund.

The Upside: Trading volume in both the long and short PowerShares DB U.S. Dollar Index funds generally seems to heighten around inflection points as the greenback shows signs of being overbought or oversold. Trading in neither fund is currently elevating this concern, with the recent appreciation of the bear fund developing in very low trading volume. The price of the underlying U.S. Dollar Index could drop in the short-term another 3 per cent to the next support area, but a 10 per cent move down to the level the index was priced at before both the 2008 financial crisis and the more recent Euro crisis would be an anticipated trend for dollar bears. Of course, the bear fund tracks the inverse of this performance.

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The Downside: Believe in a U.S. economic recovery? Think higher U.S. short-term interest rates are imminent? Afraid that the European house of cards will collapse? Then maybe this is not the trade for you. A small rally for the dollar over the very near term is also a possibility. A price drop of the bear fund below $25 would be an appropriate stop on this trade.

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About the Author
Skot Kortje

Skot Kortje has been analyzing stock market trends for 15-years using trend analysis. His Stock Trends indicators have been published by The Globe and Mail since 1995. More

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