Five Key Questions About The US Dollar: Did the USD make an important double top the 1^st week of December 2015? If so, is the USD beginning a “tradable correction?” If so, how deep could it be? If so, what are the best trades to make? If it’s NOT beginning a correction then how much higher can it go and what are the best trades to make?

Comment: For the past few years I’ve maintained that, “It’s all about the US Dollar!”  It’s not that the CAD went down…it’s that the USD went up. It’s not that Crude went down…it’s that the USD went up…etc. The USD is the “other side” of so many markets…so the most important thing is to get the USD right!

Question #1: did the USD make an important double top the first week of December 2015? So far the answer is “Yes.” 

The market made a new 12 year high (just barely taking out the March high) and then made a  classic Weekly Key Reversal (WKR) down…often a signal that a market has made an important trend change. The USD has now remained below its 12 year high for 3 weeks…adding to the significance of the WKR down. However…it’s Christmastime…trading volumes are thin…and technical signals may be less “valid”…so watch what happens when the currency markets come back “full force” the first week of January… a break below the November lows (~9660) would reinforce the “important double top” theory…and point to lower prices.

Question #2: Is the USD beginning a “tradable correction?”  Maybe. I believe that the USD bull market began May 2011 and ran for 4 years to March 2015…up ~37%…with most (~80%) of that gain coming in the 11 month period from May 2014 to March 2015.  The USD dipped ~7% to the mid-August lows…then rallied back to (barely) make new highs the first week of December.

The long USD trade is described as the most “over-crowded” trade in the market today (CFTC COT data show USD long positions near record highs the first week of December.) Commodities, currencies and especially commodity currencies have sold off hard against the rising USD. The “Weak Loonie” story was “front page news” in the Globe and Mail. Major American corporations regularly cite the strong USD as the reason for poor international revenues. IF…and this is the BIG IF…market psychology begins to believe that the USD bull market has “run its course” then the “over crowdedness” of the Long Dollar trade could cause it to have a swift correction.

Question #3: How deep could the correction be? An obvious target would be the August 2015 lows (~9260)…almost exactly the 38% Fibo retracement of the powerful rally from May 2014 to March 2015. 

A deeper target would be the (~8990) highs of 2009/2010 (what was once resistance become support)…almost exactly the 50% Fibo retracement of the May 2014 to March 2015 rally(see above chart)…and almost exactly the 38% Fibo retracement of the full rally from the 2011 low to the 2015 high (see chart below.)

Question #4: If the USD is going to have a correction what are the best trades to make? 1) Keeping it simple…short the USD. 2) Buy those markets that got hit the hardest because of the strong USD…especially those markets that are vulnerable to a “short-covering” rally…for instance…the Euro. 3) Buy commodities. 4) Buy commodity currencies. 5) Buy companies that were hit “extra-hard” because they were leveraged in favour of a weak USD…for instance…shares of resource producing companies (the Teck Resources chart below is an example of the “double wammy” effect of a rising USD and falling commodities.) 

Comment: The “long USD trade” is “over-crowded” because there are very powerful reasons to be long the USD (divergent central bank policies…safety and opportunity…the Euro is fundamentally unstable…leads and lags in capital flows…massive unhedged USD borrowings…etc.) but remember when a trade gets “over-crowded” the least little thing can cause a correction.

Question #5: If the USD is NOT going to have a tradable correction how much higher can it go? My principle trading theme over the past few years has been that the USD is in a multi-year bull trend…therefore my current “preferred scenario” is EITHER that the USD has a correction here and then goes on to make new highs…OR…the 3% set back in December WAS the correction…and it breaks out above the 100 level in early 2016 and REALLY picks up speed to the upside as the market “capitulates” to the strong USD idea. If I HAD to “lock up” my personal assets for the next 2 years EITHER 100% long USD or 100% short USD I would choose long. I don’t have to make that choice…but it does illustrate how TIME impacts my decision making. 

How much higher can the USD go? I don’t know…but probably much further than we can imagine. (Consider the inverse of this quote from my friend Dennis Gartman, “When a market is going down you have no idea how far down, down is.”) One thing I’ve learned from trading currencies for 40 years is that currency trends go WAY further than seems to make any sense…(and then they “turn on a dime” and go the other way…which is actually further evidence that they went WAY too far in the first place!)

Question #5b: What are the best trades to make if the USD goes higher? 1) Again…to keep it simple…buy the USD. You could simply “swap” your currency for US Dollars. 2) If your base currency is the USD (or if you want to be more aggressive) then look for ways to leverage your position…for instance…buy US Dollar futures (which gives you a long USD position against a basket of other currencies.)  3) Short other currencies and commodities in a manner that fits your risk tolerance. 4) Short stocks and credit instruments that are vulnerable to a rising USD. Realize that whatever you do is a “spread” bet in favour of the USD…for instance…buy a basket of American stocks that generate their income within the USA and sell a basket of American stocks that generate a significant part of their revenues overseas.

Historical perspective: When you look at the chart below you might ask yourself, “Does price action from 20 or 30 years ago have any meaningful impact on today’s prices?” I think it does…especially in the context of “those who do not learn from history are doomed to repeat it!” Depending upon your “preconceived notions”  when you look at this chart you might see a market that has been trending lower…on balance…for the past 44 years…OR…you might see a market that has just begun to break out to new highs from a multi-year base building phase.  

Bottom line: For my short term trading I REALLY pay attention to market psychology and how it creates “positioning risk.” Right now I believe the market is “over-long” the USD and at risk of a tradable correction. I’ll structure my short term trades with that in mind…but if my trades don’t work I’ll close them out / reverse them quickly because I think the USD is ultimately headed higher.