Currency Bets Hit Record Highs Again — And Doubling Up On The Dollar Rally

After embarking on a bullish trend since it bottomed in mid-July, the U.S. dollar had been coming under pressure during the past three weeks on fears over the U.S. fiscal position if Congress passed the Bush administration’s $700 billion financial rescue package. Yet surprisingly, the U.S. dollar staged a dramatic comeback last week, putting in its best performance for 16 years. The dollar index, which tracks its progress against a basket of six leading currencies, rose 5% during the week, its largest gain since September 1992. And here’s why I expect that trend to continue.

The strength of the U.S. dollar has taken many commentators by surprise. But you have to dig far beyond the headlines to understand that the U.S. fiscal position as a percentage of GDP is not nearly as bad as the headline numbers would indicate. And adding the $700 billion of the rescue package to the U.S. fiscal deficit in 2008 as some financial journalists are doing is inaccurate and probably making their college Economics 101 professors squirm. As I indicated in last week’s The Global Guru, the $700 billion will be used to buy distressed assets at fire sale prices. With a bit of luck, the rescue package may actually make Uncle Sam a pretty penny, improving the U.S. fiscal position considerably in the future.

However, the potential negative effects of the $700 billion package on the U.S. dollar took a back seat to investor concerns about the woes facing the European financial system. Just as Europeans began to celebrate the demise of U.S.-style capitalism, authorities in both the United Kingdom and the eurozone were forced to step in and rescue no fewer than four banks in the first two days of last week. And by this morning, Ireland, Greece, and Germany were all forced to guarantee all of the deposits of its banks, even as Germany’s effort to save Hypo Real Estate, the mortgage lender, faltered before an accord to inject a further €15 billion into the lender took the cost of its rescue to €50 billion.

The bottom line? The growing importance of the euro notwithstanding, the U.S. dollar remains the world’s reserve currency and when investors seek liquidity and safety, they still turn to the U.S. dollar. That alone will ensure that the greenback will continue to rally, even in the midst of global financial turmoil. So buy the Direxion Funds Dollar Bull 2.5x Fund (DXDBX) at market today, and place your stop at $31.50.

PORTFOLIO UPDATE

Your bet on the Market Vectors Double Short Euro ETN (DRR) hit a record high of $50.25 in intraday trading on Friday as the U.S. dollar rose 5.6% to $1.3788 against the euro during the week, hitting a one-year high of $1.3702. Although the European Central Bank left interest rates unchanged at 4.25% after its policy meeting on Thursday, Jean-Claude Trichet, president of the European Central Bank, warned about growth in the eurozone. Look for the euro to weaken further as the European banking crisis unfolds. Raise your stop to $40.50.

Your short position in the British pound sterling through the CurrencyShares British Pound Sterling Trust (FXB) gained this week as the U.S. dollar rose 3.8% to $1.7750 against the pound. That was the pound sterling’s worst performance against the U.S. dollar since October 1992, just after the pound was ejected from the European exchange rate mechanism. The U.K. government’s bailout of mortgage lender Bradford & Bingley rattled investors, while a series of gloomy economic data heightened expectations that the economy was headed for recession. With economists predicting that interest rates in Britain will drop to a new 50-year low in the coming months, and the Bank of England’s monetary policy committee (MPC) expected to start the process by cutting rates this week — the pound sterling has a long way to go.

Your safe haven currency, CurrencyShares Japanese Yen Trust (FXY), was the only major currency to advance against the U.S. dollar, rising 0.2% to Y105.72. The yen is one of the few asset classes out there that is actually above its 200-day moving average. 

After being the top-performing sector in U.S. markets during the past few months, the S&P Biotech ETF (XBI) has broken through its 200-day moving average on the downside. I recommend that you sell XBI and its options today at market before the stock hits its stop loss.

P.S. Surging oil and food prices, as well as deteriorating economic confidence, have stoked inflation fears around the world in recent months, leaving volatile markets and jittery private investors in their wake. In times such as these, it’s good to have this forum to discuss key developments and to hear from the best financial minds in the world. I invite you to join me at the 4th Annual World Money Show London, 14-15 November, at the Queen Elizabeth II Conference Centre. Call 800/970-4355 and mention priority code 009613 or visit The World Money Show London to register FREE today!