This was a volatile week, but most of the volatility was to the upside.
Among the currencies, the EUR was strongest, rising 4% to close at 24.9 mg. The USD was second, up 2.7%, closely followed by BTC, which gained 2.4%. The laggard was the JPY, which still managed a respectable 1.8% gain. More comments on the USD later in this post.
Bonds rose this week, but both long and short term treasuries rose less than the underlying USD, with the short term SHY gaining 2.6%, and long term TLT rising only 1.6%. Even so, TLT managed to get back above its 200 day moving average on Friday, so the jury is still out on whether this retest of resistance will be the start of a new leg down, or a breakout to the upside. Stay tuned!
Stocks were all higher, lead by the Nikkei and the S&P 500, which each rose 3.9%. The HUI gold stocks were the weakest, rising only 0.3%. At 2.22g, the Nikkei bears close watching, as it is getting near the resistance area around 2.3 g. This area was support in early 2009 and early 2011, but after the breakdown in August of 2011, it has been retested several times as resistance. As with TLT, we will have to wait and see if the rally runs out of steam around 2.3 g, or breaks through to start a new uptrend.
Commodities were mixed, with coffee, crude oil and cotton higher, while silver and copper fell. Coffee showed a huge 9.6% gain, but this was mostly due to the expiration of the December futures causing the price to shift to the March contract. Just as it was going off the boards on the 18th, the Dec contract made a new all-time low at 133.5 mg/lb. Crude oil continued last week's rally, rising a further 5% to close at 1.67 g/bbl. Silver was the week's biggest loser, falling 5.6% to close at 0.563 g/oz.
To my mind, the big news of the week was that the USD is finally approaching overbought territory. I follow the half-life of the USD closely, and try to buy USD (and USD denominated assets) when they are undervalued, i.e. when the actual price of the USD is below the predicted curve, and sell USD related assets when the USD is strongly above the predicted value. Here is a new chart showing how far above or below predicted value the USD has been over the last decade.
As you can see, whenever the USD gets more than 10% above the curve, it represents a pretty good time to sell. At 20% above the curve, it is a screaming sell! The reverse is true when the USD is undervalued by 10% or more – that's the time to sell some gold and acquire USD assets.
The last time the dollar was this far overvalued was back in August of 2009, when gold was about $935 per ounce. To get back to the 25% overbought level (last seen in late 2008, when gold was $713/oz) gold would have to fall to about $1,450 in the next few weeks.
I do think it is much riskier to play the long side of the USD than the short side. The long term trend is down, not up. And the recovery from oversold conditions assumes that the central banks will be able to do something to inspire confidence in the currency, or at least instill a sense of fear about holding other assets. If they are unable to to this, the dollar could enter free fall rather than reverting to the mean.
In any case, we are now about 8.8% above the curve, approaching the magic 10% level where we will want to be selling USD and USD related assets, and either going to cash (gold) or buying assets like high quality gold stocks, productive farmland, or strategic metals that have a good record of appreciating when the USD falls.