It is possible to have a falling dollar along with strong bond and equity markets. Figure 5.1 shows that after topping out in the spring of 1985, the U.S. dollar dropped for almost three years. During most of that time, the bond market (and the stock market) remained strong while the dollar was falling. More recently, the dollar hit an intermediate bottom at the end of 1988 and began to rally. The bond market, although steady, didn't really explode until May of 1989.
COMMODITY PRICE TRENDS-THE KEY TO INFLATION
Turns in the dollar eventually have an impact on bonds (and an even more delayed impact on stocks) but only after long lead times. The picture becomes much clearer, however, if the impact of the dollar on bonds and stocks is viewed through the commodity markets. A falling dollar is bearish for bonds and stocks because it is inflationary. However, it takes time for the inflationary effects of a falling dollar to filter through the system. How does the bond trader know when the inflationary effects of the falling dollar are taking hold? The answer is when the commodity markets start to move higher. Therefore, we can qualify the statement regarding the relationship between the dollar and bonds and stocks. A falling dollar becomes bearish for bonds and stocks when commodity prices start to rise. Conversely, a rising dollar becomes bullish for bonds and stocks when commodity prices start to drop.
The upper part of Data compares bonds and the U.S. dollar from 1985 through the third quarter of 1989. The upper chart shows that the falling dollar, which started to drop in early 1985, eventually had a bearish effect on bonds which started to drop in the spring of 1987 (two years later). The bottom part of the chart shows the CRB Index during the same period of time. The arrows on the chart show how the peaks in the bond market correspond with troughs in the CRB Index. It wasn't until the commodity price level started to rally sharply in April 1987 that the bond market started to tumble. The stock market peaked that year in August, leading to the October crash. The inflationary impact of the falling dollar eventually pushed commodity prices higher, which began the topping process in bonds and stocks.
The dollar bottomed as 1988 began. A year later, in December of 1988, the dollar formed an intermediate bottom and started to rally. Bonds were stable but locked in a trading range. Data shows that the eventual upside breakout in bonds was delayed for another six months until May of 1989, which coincided with the bearish breakdown in the CRB Index. The strong dollar by itself wasn't enough to push the bond (and stock) market higher. The bullish impact of the rising dollar on bonds was realized only when the commodity markets began to topple.
The sequence of events in May of 1989 involved all three markets. The dollar scored a bullish breakout from a major basing pattern. That bullish breakout in the dollar pushed the commodity prices through important chart support, resuming their bearish trend. The bearish breakdown in the commodity markets corresponded with the bullish breakout in bonds. It seems clear, then, that taking shortcuts is dangerous work. The impact of the dollar on bonds and stocks is an indirect one and usually takes effect after some time has passed. The impact of the dollar on bonds and stocks becomes more pertinent when its more direct impact on the commodity markets is taken into consideration.
THE DOLLAR VERSUS THE CRB INDEX
In this article, the inverse relationship between the U.S. dollar and the commodity markets will be examined. I'll show how movements in the dollar can be used to predict changes in trend in the CRB Index. Commodity prices axe a leading indicator of inflation. Since commodity markets represent raw material prices, this is usually where the inflationary impact of the dollar will be seen first. The important role the gold market plays in this process as well as the action in the foreign currency markets will also be considered. I'll show how monitoring the price of gold and the foreign currency markets often provides excellent leading indications of inflationary trends and how that information can be used in commodity price forecasting. But first a brief historical rundown of the relationship between the CRB Index and the U.S. dollar will be given.
The decade of the 1970s witnessed explosive commodity prices. One of the driving forces behind that commodity price explosion was a falling U.S. dollar. The entire decade saw the U.S. currency on the defensive.
The fall in the dollar accelerated in 1972, which was the year the commodity explosion started. Another sharp selloff in the U.S. unit began in 1978, which helped launch the final surge in commodity markets and led to double-digit inflation by 1980. In 1980 the U.S. dollar bottomed out and started to rally in a powerful ascent that lasted until the spring of 1985. This bullish turnaround in the dollar in 1980 contributed to the major top in the commodity markets that took place the same year and helped provide the low inflation environment of the early 1980s, which launched spectacular bull markets in bonds and stocks.
The 1985 peak in the dollar led to a bottom in the CRB Index one year later in the summer of 1986. I'll begin analysis of the dollar and the CRB Index with the descent in the dollar that began in 1985. However, bear in mind that in the 20 years from 1970 through the end of 1989, every important turn in the CRB Index has been preceded by a turn in the U.S. dollar. In the past decade, the dollar has made three significant trend changes which correspond with trend changes in the CRB Index.
The 1980 bottom in the dollar corresponded with a major peak in the CRB Index the same year. The 1985 peak in the dollar corresponded with a bottom in the CRB Index the following year. The bottom in the dollar in December 1987 paved the way for a peak in the CRB Index a half-year later in July of 1988.
Read More : THE DOLLAR MOVES INVERSELY TO COMMODITY PRICES
