Stock selloffs ignite dollar rallies

The entire dollar gains during the stock panic, which sparked its biggest and fastest rally ever, happened only when the SPX was plunging. At all other times, the USDX was generally sold off. And over the couple of years since that panic ended, the only times we’ve seen large and sharp USDX rallies (with the single exception of that dollar-oversold episode) was when the SPX was pulling back or correcting.

There is no reason why this behavior shouldn’t continue. Since stock-market selloffs drag all sectors lower, none escape, the best trade to own during these events is cash. It preserves your capital while your effective stock purchasing power grows as share prices decline. Demand for cash will always surge during a major stock-market selloff, and this will continue to drive major dollar rallies. I have no doubt that the US Dollar Index will again surge when this next overdue SPX correction finally arrives.

Now if you own stocks in most sectors, the dollar’s action is largely irrelevant. Apple is going to keep selling iPhones and iPads like hotcakes regardless of which way the dollar meanders. But if you own commodities stocks, these SPX-driven dollar surges are huge deals. Your commodities producers’ profits are driven by the prices of their underlying commodities, and these prices take a hit whenever the dollar rallies. When traders bid the USDX higher, it takes fewer dollars to buy any given unit of commodities.

So commodities stocks are hammered from multiple fronts during stock-market selloffs. Like all sectors, they are sold off simply because the general stock markets are falling. And since professional traders still consider commodities stocks riskier than many other sectors, they tend to leverage the declines in the stock markets. Larger commodities stocks often double whatever the SPX decline happens to be.

And a stock-market selloff’s parallel impact on the dollar compounds this selling pressure on commodities stocks. As traders see the commodities prices critical to producers’ profits drifting lower, they start to fear for this sector’s core fundamentals. So they accelerate their selling even beyond what the stock markets would suggest is reasonable. A rising dollar alone weighs on commodities prices and hence commodities stocks, but coupled with an SPX selloff the resulting impact is freight-train hard.

The natural reaction of traders to any stock-market selloff is to assume the economy must be deteriorating if stocks are down. Usually this is incorrect, as periodic selloffs within ongoing bulls are usually simply driven by technicals (prices rallied too far too fast) and sentiment (consensus is too bullish). They have nothing to do with fundamentals at all. But when a fast dollar rally drives falling commodities prices in concert with an SPX selloff, this bearish economic psychology metastasizes into fundamental concerns.

So when the stock markets are falling, the dollar is surging, and commodities prices are weakening, Wall Street endlessly declares that commodities stocks are falling for fundamental reasons. With lower commodities prices, their profits will deteriorate. Provocatively, you usually hear bold declarations that the secular commodities bulls (or “bubbles”) are finished during these SPX-selloff events. This naturally leads to a really-negative environment for commodities stocks. They are often beaten to a pulp.

This probably sounds depressing at this point, but it really isn’t at all. Our goal as speculators and investors is simple, to buy low and sell high. In order to buy low, we need selloffs periodically to drive commodities-stock prices low enough to be relatively-cheap bargains. SPX selloffs, which are inevitable, healthy, and necessary to keep sentiment balanced, drive the best buying opportunities ever seen in this entire commodities-stock bull. These selling events should be gleefully anticipated!

The bottom line is stock-market selloffs ignite major US dollar rallies. And these are almost the only times the dollar surges, as the vast majority of its rallies in the last few years coincided perfectly with stock selloffs. Cash is the natural and prudent refuge in times of falling stocks, as it preserves capital while its purchasing power increases. But the resulting dollar surges weigh heavily on commodities prices.

This is a problem for commodities stocks, especially if they produce commodities with prices particularly sensitive to dollar action. These weaker commodities prices combine with the general bearishness of falling stocks to lead to outsized losses in this sector. While tough on traders not expecting this behavior, it is a huge boon for those who do. It leads to the best commodities-stock buying opportunities ever seen in their ongoing bull markets.

Find out more information about Zeal's reports, and contact Adam Hamilton, CPA, at www.zealllc.com.

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