Data Brief - The Dollar's Jump - A Commodity Killer?

The Dollar's Jump - A Commodity Killer?

Tuesday, June 10, 2008

"Dollar Jumps on Remarks By Paulson, Biggest Gain in Two Years"

"Greenback Surges on Bernanke Comments"

"US Currency Finally Sees Some Relief"

Those are just a few of the headlines that populated the news wires over the past day, as a confluence of forces led to a 1% gain in the US Dollar Index.

In early May, we took a look at the Euro, and based on some sentiment measures suggested that the currency was probably about to see a short-term bounce, but probably nothing more than that.

Because of their close (inverse) relationship, a rally in the Euro would likely coincide with a decline in the US Dollar, which had seen a spike in enthusiasm that the multi-year decline had finally ended. So, a short-term rally in the Euro would should almost certainly coincide with a short-term peak in the Dollar.

We did see that happen, as the Euro rallied and the Dollar fell for the next couple of weeks. In the meantime, not much has changed sentiment-wise. We're still seeing heavy speculative selling in the Euro, we're still seeing Rydex traders bet on a Dollar rally, and the other measures we touched on haven't changed much either.

But there is one thing that may have changed - the behavior of the Dollar itself. Due in part to a speech by Fed Chairman Ben Bernanke, the Dollar has exploded over the past couple of days, rising nearly 2%. That may not sound like much when the S&P 500 now regularly posts 3% daily moves, but for the Dollar Index it's the largest two-day move in more than three years.

So let's revisit the Dollar, taking the move today in particular into account. As the headlines are blaring, the Dollar's gain today (just over +1.15%) was the largest single-day jump in more than two years, so let's take a look at how the Dollar has responded in the past to large gains. We'll also take a look at a few commodities to see if there was any impact there.

The table below shows the future performance in the US Dollar, Gold, the CRB Index and Crude Oil after the Dollar gained at least 1% in a single day, and also scored at least a three-month high in the process, but not more than a six-month high.

This will give us other times that we saw a big daily gain to an intermediate-term high, while eliminating times when the Dollar was already extended by setting multi-year highs, for example.

Many commodities and currencies are favorable to trend traders, which is why we see many of the big hedge funds employ those strategies to those markets, and usually avoid mean-reversion types of markets like stocks and bonds.

One characteristic of trends is autocorrelation - basically, when a price moves in one direction, it tends to keep going. That doesn't work in the stock market, but it does in some commodities.

We see that to some degree in the table above. When the Dollar made an impressive move like it did today, then it has tended to keep going. A month later, the Dollar was higher 70% of the time, and tacked on another 1.4% on average.

Because many commodities run inverse to the Dollar (in general), it's not surprising to see that the other commodities in the table didn't fare so well. After a month, Gold was higher barely 1/3 of the time, as was Crude Oil.

There are a lot of moving parts when analyzing currencies and commodities, and this barely scratches the surface. Our point is to try to make some sense of the headlines screaming about today's gain in the Dollar, and see if we can use it to our advantage. While sentiment on the Dollar still seems a bit "too much", today's move is encouraging.

Should we see the currency continue to build on these gains, it should help usher along a much-needed correction in the commodities markets.