During the height of pandemic panic in 2020, the dollar was a safe haven. That’s because during times of turmoil, foreign central banks and other financial institutions used the greenback to anchor their currencies from collapse.
So, it was no surprise that at the height of the pandemic panic from March 9 to the bottom of the crash on March 23, the dollar rose 8.3%. This was the stretch where the financial world was desperate for liquidity, as nearly every asset in the market was in free fall.
But on March 20, 2020 – three days before the stock market bottomed – the dollar began to fall from its highs. With the initial shock of the pandemic behind us, the need for safe-haven assets started to disappear.
Add to that unprecedented money printing from the Fed… And today we have the dollar trading at a three-year low.
Since those highs last March, the U.S. Dollar Index (DXY) has fallen 12.5%. That may not seem like a lot, especially compared to the volatility in the stock market. But it’s a huge move for the world’s reserve currency.
This decline has caused two major dynamics to emerge: The dollar’s purchasing power of everyday goods and services is lower… And this has helped fuel the biggest commodities rally we’ve seen in nearly a decade.
This all sounds like bad news for the greenback. But on Monday, China’s central bank sent a subtle yet effective signal that the dollar’s decline is actually about to end…
And, as is the usual case, Jeff sounded the alarm of a potential dollar reversal long before this announcement ever happened… And before it was on anyone’s radar.
So today, we’ll dig into what this announcement means for the dollar’s near-term future, which sectors are most vulnerable, and what you should do to take advantage of this unique scenario.
China’s Gift to the Greenback
On Monday, the PBOC (People’s Bank of China) announced it will force financial institutions in the country to hold 7% of their foreign currency in reserve, up from 5%.
That means that these institutions will have to hold more U.S. dollars in their treasuries than before. That will effectively reduce the supply of dollars… And force traders and banks to stop selling them, which should cause its value to rise.
It effectively did this to stop its own currency, the yuan, from appreciating.
Let me explain…
Chinese bonds have a relatively high-interest rate, and economic conditions are stable – a combination that’s sending currency flows away from the dollar and into the yuan.
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Contrary to popular opinion, China doesn’t see a higher yuan as an offsetting mechanism for higher commodity prices… Instead, a higher yuan will hurt their exports. Because as the yuan appreciates, it becomes more expensive to import from China.
So broadly speaking, this move from China encourages Chinese institutions to hold more dollars, which slows down currency flows from the dollar to the yuan.
That could help strengthen the dollar. And if the dollar strengthens from here, it could reverberate across virtually all financial markets… This would give dollar-sensitive areas – especially the commodity sector – a breather from their breakneck rise.
It’s Time for Commodities to Cool Off
Commodities have racked up massive gains since the dollar’s peak last year. Take the VanEck Gold Miners ETF (GDX), for instance, which is up nearly 100% since the dollar peaked.
With 80% of its holdings in foreign miners, the effect of a declining dollar has been substantial. The increase in GDX has not just been about gold and silver prices – it’s also about the dollar falling.
But it’s not just about precious metals. Take another dollar-sensitive sector: agriculture. The VanEck Agribusiness ETF (MOO) gained almost 110% since the dollar’s peak.
The price of agricultural commodities like soybeans and corn are tied to global currency trends. So, a declining dollar has boosted their value – and in turn, companies associated with the production and marketing of these products…
But with China signaling that it’s no longer comfortable with its currency appreciating, these sectors are about to take a breather.
I’ve been a bull on commodities for a long time, as have many of my colleagues at the Legacy family. Even before talks of inflation, and the new commodities supercycle became mainstream topics.
That’s why I read our research first, then everyone else’s.
But, with the PBOC requiring banks to hold additional USD reserves, these key areas that have skyrocketed are now perfect to take profits and wait for better prices.
If you have exposure to the commodities I mentioned today, it wouldn’t be a bad idea to take profits. If you’re still bullish, look to implement a trailing stop-loss on your position, to ensure your profits aren’t wiped out.
More aggressive traders can look to speculate on some downside in commodities by buying put options on GDX or MOO.
While I believe this will be a temporary condition, this is a great setup for traders seeking short-term profits.
Regards,
Eric Shamilov
Contributing Editor, Market Minute
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