WHY COMMODITIES ARE STRONGER THAN THEY APPEAR WHILE THE DOLLAR IS WEAKER -- TOO MUCH FOCUS IS BEING PLACED ON THE WEAK EURO AND NOT ENOUGH ON RISING COMMODITY CURRENCIES
DOLLAR STRENGTH COMES FROM EUROPE AND JAPAN ... In a message dated March 2, I expressed the view that the dollar wasn't as strong as it appeared to be. I also wrote that an upturn in commodity-based currencies would lend support to commodity prices. I'd like to come back to that theme today and suggest that the dollar isn't as strong as it appears and commodities not as weak as they appear. It all depends on which currencies and commodities we look at. Chart 1, for example, shows the DB Bullish Dollar Fund (UUP) in an uptrend since last December. The UUP shows the dollar versus six foreign currencies. The heaviest weighting by far is the Euro which accounts for 57.6% of the UUP. That helps explain why the Euro (blue line) is almost a mirror image of the UUP (green line). The three falling currencies below Chart 1 also account for most of the dollar's rise. They include the Japanese Yen (13% of the UUP), the British Pound (12%), and the Swiss Franc (3%). [The Swedish Krona isn't shown]. The point of Chart 1 is to show that the 2010 rally in the UUP is based mainly on falling currencies in Europe and Japan.
Chart 1
WHAT ABOUT THESE CURRENCIES ... Not all foreign currrencies are falling. In fact, the three shown below have been rising since February. They include the Canadian Dollar, the Australian Dollar, and the Brazil Real. What they also have in common is that they're commodity-based currencies. In other words, their trends are closely correlated with commodity prices. [Only the CDW is included in the UUP with a relatively small weight of 9%]. Hence my observation on March 2 that the February upturn in those three currencies were "good for them, commodities, and stocks". I also suggested that the decline in European currencies was making the dollar look stronger than it really was. In other words, the UUP may be focused on the wrong currencies. That may explain why stocks and, more recently, commodities have been able to rally in the face of a strong UUP.
Chart 2
STOCKS AND COMMODITIES BOTTOM WITH CDW... All three commodity currencies bottomed together in early February. I'm using the Canadian Dollar in Chart 3 because it's the strongest of the three. Notice that the upturn in the Dow Jones World Stock Index (above chart) and the CRB Commodity Index (below chart) started at exactly the same time during February that those three currencies turned up (see arrows). That suggests that stocks and commodities have been trading more off rising commodity currencies than falling European currencies over the last two months. That also suggests that the current trend in the UUP has become less important to stocks and commodities.
Chart 3
AGS MASK OTHER COMMODITY GAINS... The point of Chart 4 is twofold. One is to emphasize that most commodity groups turned up in early February along with the three commodity currencies (not shown here). The second purpose is to demonstrate that agricultural markets are making the commodity gains look smaller than they really are. The main portion of Chart 4 shows the DB Commodity Tracking Fund (DBC) just breaking through its March high. By contrast, the PS Energy ETF (DBE) is testing its 2010 high (crude oil has already hit a new high), while the Industrial Metal ETF (DBB) is right behind (copper has already hit a new record). The third line shows the Precious Metal ETF testing its March high (silver has already broken out). By contrast, the PS Agricultural ETF (lowest line) has continued to drop sharply. The DBA is being pulled lower by grain and sugar prices. Of all the commodity groups, agriculturals are the least economically-sensitive (and are driven by crop and weather conditions). As a result, weakness in that group is preventing commodity Indexes (like the CRB and DBC) from showing stronger gains. And, in my view, that is masking the much stronger gains in economically-sensitive commodities like energy and metals. Which brings us back to my original point that too much focus on the weaker Euro is calling attention away from rising commodity-based currencies, while weak agriculatural markets are masking gains in more economically-sensitive commodities. In other words, the outlook for commodities (and their related shares) is even better than it looks on the charts of the U.S. Dollar Index and the CRB Index. And, to the extent that rising commodities reflect economic strength, that's positive for stocks as well. The only market it's bad for is bonds.
Chart 4
