As I mentioned on last week’s Smart Macro segment on our podcast (see Is the US Facing Stagflation?), I think we are in a consolidation period for precious metals as sentiment became too frothy and sentiment on the USD too bearish. Non-Commercial hedgers (“dumb money”) are the most short the USD since the early 2018 bottom. When their short positions get to this lower extreme, that usually indicates a bottom as seen below (green shaded regions).
If the USD is no longer in a bull market and is transitioning into a bear market, counter-trend rallies in the USD should be short lived as they were between 2002-2007.
The reason why I am bearish on the USD longer-term, however, is due to the extraordinary widening of the US trade and budget deficits, which tend to lead the USD Index by roughly 18 months and argue for a sharp drop in the USD (~ 25%) over the next two years.
In addition to the deteriorating US fiscal position, monetary policy differences between central banks also play a meaningful role in exchange rates. The sizable jump in the Fed’s balance sheet relative to the ECB's argues for a higher euro relative to the USD and we appear to be in the early to mid-innings of this process.
I expect the Fed to continue to print money as the US Treasury will be issuing records amount of debt over the coming years in response to COVID-19 and the amount of debt issuance is too large for the private market to absorb (just look at the Repo crisis of September 2019), and is why the Fed will have to be the buyer of last resort. The images below is likely to be one of the primary causes of the bull market in commodities and a bear market in the USD, pushing our debt to GDP ratio north of 100%.
As the US fiscal position deteriorates (see below), confidence in the USD is likely to weaken, which should drive the dollar lower relative to other foreign currencies and lead to higher commodity prices.
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