Hedge funds are shorting the dollar like crazy

There is a broad spectrum of investors looking for the dollar to rally, which should help trigger a pullback in stocks, metals, and commodities. The trouble is, many of their arguments were the same ones used in September.

On the surface, the arguments have a little bit of support. The buck closed above a widely-watched moving average for the first time in months on Monday. That ended a streak of 2 months below that average, the longest in nearly a decade. This is the kind of streak the dollar consistently underwent during structural bear markets, with only the last one in the sequence (sometimes) ending up leading to sustained gains. 

It's a tempting argument, with large speculators holding nearly 40% of dollar futures open interest net short, one of their largest positions ever. On a chart, it seems like the extremes tend to line up with turns in the dollar, but charts can be misleading.

U.S. dollar speculators net short

The dollar's annualized return when speculators held more than 20% of open interest net short was -1.2%. Returns were significantly higher when speculators were net long a large share of open interest. This is the opposite of what we see in most other contracts.

When we look at all substantial 3-day rallies in the dollar when speculators were holding a large net short position, we can find no consistent evidence that this is the type of behavior that leads to short-covering. In fact, the best-performing market over the next 3 months was one that a rising dollar should hurt the most.

This is why we test - markets do a very good job at screwing with people who try to use logic instead of human nature.

What else we're looking at

  • What happens to the dollar after it ends a long downtrend
  • Forward returns following short-covering rallies in the dollar
  • A look at more than a dozen markets and factors following nascent short-covering rallies
  • What happens to 10-year yields after a run like the past week
  • Gold mining stocks have taken a tumble, triggering some extremes in breadth
  • A 2-fund portfolio that has gained 38 out of 42 years to start the year
  • The high-yield market is not throwing off any warning signs

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Stat Box

Only 2% of gold mining stocks are trading above their 10-day moving averages, the fewest since November. Dating back to 1993, this is a low enough reading to rank in the bottom 2% of all days.

Sentiment from other perspectives

Don't mix business and politics? Don't tell small business owners that. There was a jump in optimism when the Trump administration took over, and now...not. Source: Piper Sandler via Daily Shot

small business optimism

Business owners might be feeling a little less optimistic, but day traders sure aren't. Powerd by social media hype, "story" stocks have been taking off, and not letting up yet. Source: Wall Street Journal

nio tweets and share price

This is the kind of activity that draws investors - okay, traders - into penny stocks. Volume there has been exploding, and for now, it has been rewarding. Source: Bloomberg

penny stock volume

The post titled Hedge funds are shorting the dollar like crazy was originally published as on SentimenTrader.com on 2021-01-13.

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