Simit Patel

As I've blogged many times before, I view the Federal Reserve, the semi-governmental organization that manages the value of the US dollar, as having an inflationary bias, and that they will be able to create the inflation they so desire. I look for trading opportunities consistent with this perspective.

While opportunities have been a bit sparse for dollar permabears like myself in 2009, there are signs that this is coming to an end, and that dollar weakness/price inflation may be set to accelerate. Consider the evidence:

1. The US dollar index (USDX) has recently broken below a key support level.


2. TLT, an ETF tracking 20+ year Treasury bonds, has fallen below a major support level.


3. The Australian dollar and the Canadian dollar have aggressively moved beyond key resistance levels against the US dollar. The chart below shows the Canadian dollar strengthening against the US dollar.


What This Means And How to Trade It

There is a school of thought which suggests that traders can make 90% of their trading wealth in 10% of market conditions; the rest of the time the trader should be in risk-averse positions designed primarily to preserve wealth. I am a proponent of this school of thought, and I mention it because I think we are in or are in the midst of that ideal 10% of the time. Major levels have been broken, which leaves the market ripe for movement.

In terms of how to trade this, I will quickly recap the inflation trades I've noted previously:

• Gold/silver
• Short 20+ year Treasury bonds
• Commodities
• Commodity currencies (Australian dollar, Canadian dollar)

Long gold/short 20+ year Treasury bonds has performed well thus far this year and is on track to continue doing well, in my opinion.

Key Event: Stock Market Selloff

It seems likely, in my opinion, that we will see somewhat of a stock market sell off. If this occurs, where will extra money go? Will it go into Treasury bonds, as it did in the second half of 2008 when the stock market sold off? Though I would argue the fundamentals underlying Treasury bonds are atrocious and thus do not make them an appealing investment, investors did rush back into Treasury bonds during the economic struggles of the second half of 2008. If the stock market sells off again in 2009, something that still seems quite likely, will investors once again flee to Treasuries?

Perhaps. Indeed, the historical precedent is certainly there. However, given the US' diminishing tax base, growing government expenses, and the fact that the Fed has already begun printing money to make up for the declining demand for Treasury bonds, I think this trend cannot last forever. If the US does not revise its monetary policy and/or reduce government spending, I think there is a risk of investment dollars leaving all aspects of the US economy -- private sector, public stock markets, debt markets, etc.

Disclosure: Long gold, silver, Canadian dollar.

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