Monday, September 19, 2011

Strong Dollar?

The secret to making money in markets is to invest in bullish trends. Doing literally only that and nothing else will allow you to beat most money managers while sleeping like a baby at night. Accurately identifying the bull markets and placing capital in front of a trend is what trips people up.

The problem is that we have been taught to look for linear solutions to life and markets do not cooperate. Anytime someone utters the words "buy low, sell high", simply remove yourself from the conversation to avoid psychic damage. There is no such strategy as this amateur is not likely to possess the ability to price investments on a relative basis.

What is a low price? Anyone with real experience in markets will gladly tell you about some of the traps they have fallen into. We have all bought a stock because it was "cheap" only to later realize that it was about to get even cheaper! Cheap is a relative term and things are only priced in relation to other things. Once accurate pricing has been applied to an issue, then an assumption concerning future conditions should be made in order to predict what the market will offer in the next cycle.

The first step in simplifying your investment life is to identify the major trends currently in place. You can do this exercise on your own but objectivity is the key. Confirmation bias, nostalgia, normalcy bias and other behaviors learned in an effort to feel safe can disrupt this process. In the end, drawing a long term chart is the safest way to identify a basic trend.

Let's use a chart of the US dollar as an example. We will feature NYSE:UUP, the Deutsche Bank Dollar Index Bullish Fund, but you are welcome to use a different metric.

The first thing we should notice is that there is a major, multi-year downtrend in place. That downtrend should be perceived as the major plot in a 1,000 page novel. Throughout the story things will happen but the overall plot will be in place. If the major bands of the chart are broken then the book is over and you must move on to the next one in the series.

Within the context of this major, long-term trend we see that last June represented a test of the top trend line followed by a renewed downward advance. By February 2011 we could establish the short-term downtrend line labeled on the chart. This structure represents a bearish pennant. Picture a line moving from left to right within the confines of a baseball pennant. As it approaches the tip it must make a definitive break either up or down which will indicate a new short-term direction.

To our surprise the dollar recently broke its bearish pennant and shot higher. This was likely due to the realization that Europe is insolvent and most of the world is effectively bankrupt. Fascist leaders are clearly scrambling to defer the costs associated with poor decisions onto the public and so far it is working.

For now, this move higher is a bullish rally within the confines of a well-defined bear market. If you doubt this statement, go back and draw a chart of the dollar from 2001, then from 1971. These short bursts of buying do not subvert the well-defined trend.

On August 15th 1971 Richard Milhous Nixon removed the US dollar from the gold convertibility standard put in place at Bretton Woods in 1944. Since that time we have operated on a floating exchange rate system. The net effect has been a 40-year, 5-week persistent decline in the purchasing power of the US dollar. Only brief rallies have occurred during this sustained downtrend. We are reluctant to trust that capitulation will occur until change is forced upon the political class by economic circumstances.

Do you trust men like this to determine the value of your hard earned savings?

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