Why I'm Bullish on the Dollar

There's a simple reason why I think that all the dollar doomsayers are wrong: I'm bearish on the euro.

It's fashionable to bash the dollar right now. Fundamentally, there's not much to like about the U.S. currency -- deficits as far as the eye can see, ultra-easy monetary policy, high unemployment, and a still-far-from-stable banking system.

But as we found out in December, the euro is not much better. The euro fell from $1.51 to a recent low of $1.42. This is one reason why we saw a large correction in gold bullion and gold stocks, and a sizeable sell-off in some sovereign bond markets, but relatively little impact on U.S. stocks.

There's more to come in the euro decline
As it turns out, I was early in calling for a drop in the euro; the dollar has spent most of 2009 giving up its gains from a year ago. But even though my timing was bad, my article's long-term fundamental views on the euro's future were sound. Finally, the market has begun to realize that.

The euro truly is the key to the dollar's overall health. If you look at the weightings in the basket of currencies that make up the Dollar Index, you'll see that the euro makes up more than half of the index. So if you're bearish on the euro, you almost automatically have to be bullish on the dollar.

Before you dismiss the argument out of hand, consider that the euro has a structural weakness: There is a European Central Bank, but no single unified Treasury. Often, centralized monetary policy has been out of sync with fiscal policy among European countries, which can create substantial pressures on the euro. There is huge political risk that the market is only now starting to appreciate.

Uninformed comment?
This political risk has been most evident in weaker European economies like Greece and Ireland. The Greek and Irish euro-denominated sovereign bond markets have both sold off substantially, increasing the yield spreads between them and the benchmark euro-denominated German bunds. There have also been sovereign credit downgrades in the region, prompting one bank to speculate that Greece and Ireland might leave the euro next year. The Irish government called this speculation "uninformed comment," but it's clear that these and other countries are putting pressure on the euro's viability.


Purchasing Power Parity in Euros per U.S. Dollar









Source: OECD. PPP comes from latest available 2008 annual figures based on actual individual consumption.

As last year's purchasing power parity (PPP) figures for Europe's largest economies show, the euro is still wildly overvalued. At its current level of around $1.43 to the euro, a dollar is worth a little less than 0.70 euros. But as the table shows, it takes more than 0.70 euros to buy a dollar's worth of goods. To match up with the German PPP of 0.803, the exchange rate should drop to below $1.25.

In this environment, any political and economic issues among the weakest countries in the Eurozone are likely to pressure the exchange rate. I see more euro downside, which might hurt earnings of classic multinationals like Coca-Cola (NYSE: KO  ) , Procter & Gamble (NYSE: PG  ) , and McDonald's (NYSE: MCD  ) . It will also stifle prospects for stocks in Greece and Ireland, at least until the fundamental picture resolves itself.

Euro effect on gold
Over the past year, gold has moved in line with the euro's advance against the dollar. At the moment, a weak euro has been accompanied by weaker gold prices as measured in U.S. dollars.

Although troubles in the U.S. seem to justify a weaker dollar, the fact is that most central banks are taking similar measures. Those actions arguably make all paper currencies equally bad stores of value, if the process continues ad infinitum. We have been assured of an "exit strategy" by many world central bankers, but we have yet to witness its successful implementation. This should be bullish for gold in the long term, but in the short term, I see a deeper correction as the euro declines.

Right now, gold bullion looks like a good buy near $1,000, and an even better value if it declines toward $900. I can assure you that such decline is possible if the turmoil on the Old Continent accelerates, and the euro drops to $1.25. Gold was below $900 in March, when the euro last traded at that level.

Based on that view, I would book gains in speculative positions in small-cap gold stocks, and look to buy quality names like Barrick Gold (NYSE: ABX  ) and Goldcorp (NYSE: GG  ) on further weakness. Another one to buy on the cheap is Royal Gold (Nasdaq: RGLD  ) , which carries extremely impressive margins compared to other precious-metals related companies that I've looked at.

Longer-term, though, the policies that governments are implementing have decidedly negative implications for currency values relative to gold. If those policies don't change, exchange-rate moves could easy pale in comparison to the increases that precious metals might see. Based on my estimates, gold would need to rise to nearly $2,500 just to match its inflation-adjusted record highs, which corresponds to around $250 for the SPDR Gold Shares (NYSE: GLD  ) . So even if a deep correction comes in 2010, that might just be another buying opportunity for gold.

John Connolly, Nixon's Treasury Secretary, once told his European counterparts, "The dollar is our currency, but your problem." Soon enough, though, competitive devaluation could make weaker currencies everyone's problem.

More on market issues:

Fool contributor Ivan Martchev does not own shares in any of the companies in this story. Coca-Cola is a Motley Fool Inside Value recommendation. Coca-Cola and Procter & Gamble are Motley Fool Income Investor selections. The Fool owns shares of Procter & Gamble. Try any of our Foolish newsletter services free for 30 days. The Fool has a disclosure policy.

Read/Post Comments (9) | Recommend This Article (18)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 30, 2009, at 4:31 PM, sprooz wrote:

    I fully agree with the author since a market crash has been forecasted for march-june 2010 by a technology called ssrforecast, the gold and the dollar will go through the roof!!!

  • Report this Comment On December 30, 2009, at 6:23 PM, pgcyf2007 wrote:


    From Europe and with high international vision I find your analisis serious and useful.

    Of course in the long term USAD will become weaker and weaker but EURO will also follow a similar way even not for exactly the same reasons.

    Unfortunatly most of European Union countries economies ( not Germany) have lost a big part of its industries, allow financial sector to develop in the wrong speculative way, increase public and commercial deficits and abuse of the social protection system and public sector employment ...

    Media are highly responsible for people to develop a non critical thinking in the last decades ... regarding a right democratic system development.

    The so called democratic systems are highly controlled by the bankers / politicians groups as the most dangerous risk for real democracy and people happy future ...

    So USAD and EURO will lose value for many years from now until people oppose this kind of leadership is creating dangerous social conditions .... and bankers will be controlled and push to do is right and limited role in the economy system.

  • Report this Comment On December 30, 2009, at 7:01 PM, silverminer wrote:

    This is a solid article that brings up the important trilateral relationship between gold and the two key fiat currencies of the western hemisphere. I agree with much of the underlying argument, but would merely suggest that the enormously leveraged nature of U.S. based financial institutions into distressed derivative assets in Europe (with the inextricable backstop of those institutions by the Fed/Treasury) leaves the USD exposed to debt defaults anywhere in the Eurozone.

    This leaves me expecting derivatives to create a sort of equalizing effect that drags the dollar to weakness as well.

    Meanwhile, although the Euro zone is facing a series of troubling fiscal issues, the U.S.Treasury market is walking upon thin ice that could give way with the drop of a hat. I recommend Eric Sprott's latest commentary on the topic.

    As I've said elsewhere, I see $1,000 as strong support for the gold price. That's not to say that $900 is impossible, but I view it as highly unlikely. With central banks and other large money players having only recently shifted to a resolutely long posture after the September breakout, gold's trajectory is potentially less beholden to the near-term swings of the USDX.

    Then again, if/when we were to see renewed deleveraging here at home, the impact upon the dollar would have everything to do with where people turn for a "safe haven". Last time it was all about Treasuries. This time it would be about both Treasuries and gold, and the relative allocation between the two would determine whether the dollar reaches a critical stage sooner vs. later.

    At the end of the day, none of us can telegraph these short-term fluctuations. A single decision by a single central banker, or a single failure of one of these gigantic U.S. Treasury auctions, or a single margin call on the under-backed, leveraged bullion exchanges could render discussions of relative weakness among fiats entirely moot.

    I hope you're right. $900 gold would be quite a gift to those who arrived late to the currency protection afforded by precious metals, but I'll be redeploying most of my cash holdings above $1,000 gold. The only thing is, with the ratio of gold to silver at 65:1, I'll be targeting silver plays instead of gold.

    Fool on! Happy New Year!

  • Report this Comment On December 30, 2009, at 7:04 PM, silverminer wrote:

    I forgot I was logged in as silverminer. For the record, silverminer = TMFSinchiruna. :)

  • Report this Comment On December 30, 2009, at 11:28 PM, tkell31 wrote:

    Good points!

  • Report this Comment On December 31, 2009, at 7:08 AM, DONESONZ wrote:

    All the fiats have more holes in them than swiss cheese.

  • Report this Comment On December 31, 2009, at 9:44 AM, ivanmartchev wrote:

    I am genuinely surprised at the lack of crucifixion attempts for the "bullish dollar" argument... Glad to see so many reasonable people read the site

  • Report this Comment On December 31, 2009, at 11:43 AM, ThreeBulls wrote:

    I'm confused about bullish US dollar postures when the US Treasury has to refinance $2 trillion short-term debt in 2010 and cover another $1.5 trillion for deficit spending while California is teetering. Whether the Euro or USD is in bigger potential trouble provides a curious argument for a strong dollar. I clearly understand a position that gold might provide safe place to ride out uncertainty about both.

  • Report this Comment On December 31, 2009, at 1:18 PM, plange01 wrote:

    until obama can be stopped from thowing away trillions of dollars american currency will remain worthless...

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