The US Dollar And The Market

12/03/09 12:40:36 PM

by Koos van der Merwe

When the US dollar strengthens, the market weakens and when the US dollar weakens, the market strengthens. Is this talk or is the present movement in the market really tied to the movement of the US dollar?

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A weak US dollar is good for the US, because it makes US-produced merchandise more competitive on the world markets, with the exception of China, because the Chinese yuan is tied to the US dollar and moves accordingly. So when the US dollar weakens it is natural for the Standard & Poor's 500 to strengthen.

A weak US dollar also affects the price of gold. Under President Richard Nixon the world went off the gold standard, when all currencies in the world tied the strength of their currency to the price of gold. By going off the gold standard, they accepted the US dollar as the standard to measure their currencies against.

With the US dollar currently weak, many counties have decided to protect the value of their currency by buying gold. This has pushed the gold price up to unbelievable highs, with other metals like copper following suit. There are many mining companies making up the S&P 500, so are they the ones pushing up the index? The Dow Jones Industrial Average (DJIA), on the other hand, does not have a single gold mining company in its makeup yet it also moves contrary to the US dollar, so it stands to reason that it is the competitive price of US manufactured goods that is moving the market.

Figure 1 is a composite chart of the S&P 500, the US dollar index, and gold. Observe the following. Note that the effect and timing of interest rate reduction is not shown on the chart. This is because the effect of the interest rate reduction will affect both the US dollar index and the S&P 500:

1. From September 2000, the S&P 500 started weakening along with the bursting of the technology bubble. The US dollar index moved sideways until January 2002 and the gold price started to creep up slowly.
2. From January 2002, the US dollar index started weakening. The S&P 500 continued to weaken until October 2002, when it formed a base before strengthening. The gold price continued to strengthen.
3. On February 20, 2004, the S&P 500 suggested that it may be linked to the movement of the US dollar Index, because the dollar index strengthened slightly and the S&P 500 weakened. However...
4. From December 31, 2004, both the US dollar index and the S&P 500 both strengthened in tandem suggesting that they were not connected. Over this period, the gold price moved sideways until July 2005.
5. From November 2005, the US dollar index started weakening ahead of Ben Bernanke taking over in February 2006 and continued falling until March 2008. The S&P 500 continued rising until October 2007. The fact that it then started falling along with a weakening US dollar index suggests that the movement of the two indexes were not linked.
6. The gold price, on the other hand, started moving up strongly with the odd correction until March 2008 confirming a strong link to the movement of the US dollar.
7. On October 12, 2007, the S&P 500 started falling. The US dollar index only started strengthening in July 2008, and it looks as though from that date the two indexes were linked. As the US dollar index strengthened and weakened, the S&P 500 weakened and strengthened.
8. Over this period, the gold price strengthened as the US dollar index weakened and vice versa, almost moving in tandem to the S&P 500, but where the gold price has made new highs, the S&P 500 has still a long way to go before new highs are made.

To conclude, the chart shows us that it is only recently that the S&P 500 has started to move opposite to the US dollar index. How long this will continue to occur I believe is anyone's guess, although I do feel that interest rates will play a big part in strengthening the US dollar. When the Federal Reserve makes an announcement that they will increase rates, then we must know that the recovery in the US is truly in place and the US dollar will strengthen appreciably. The chart at present is suggesting the market could then start weakening, but a strengthening of interest rates will also show the investing public that a definite recovery is in place, and investors may flock back into the market decoupling the contrary movement of the two indexes. The gold price however will remain tied to the movement of the US dollar, which means as the US dollar strengthens, so the gold price will weaken.

FIGURE 1: INTERMARKET ANALYSIS. Here, the US dollar index, the S&P 500, and London gold are depicted.

Graphic provided by: AdvancedGET.

Koos van der Merwe

Has been a technical analyst since 1969, and has worked as a futures and options trader with First Financial Futures in Johannesburg, South Africa.

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The US Dollar And The Market

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