Dollar’s Demise Has Started a Chain Reaction in Currency and Commodity Markets

And so we begin another week in the life of the late, great, U.S. dollar. The dollar is not actually dead yet, of course. But its dying days are sure starting to get exciting. The latest phase of the dollar's demise has started a chain reaction of sorts in the currency and commodity markets.

The Aussie dollar, for example, tacked on 4.5% against the greenback last week. The Aussie is now at a seven-month high against the USD. You could be tempted to say the "carry trade" is back on. That's where investors borrow in Yen or U.S. dollars to buy higher yielding currencies like the Australian and New Zealand dollars. But we don't think that's the case. Why?

The "carry trade" was popular over the last few years when appetites for risk were healthy. They aren't so healthy right now. U.S. stocks and bonds are falling. Interest rates are creeping up.

What's more, the green shoots of economic recovery have been nearly blown away in the last week of negative economic news (mostly concern about America's credit rating). Australian stocks are set to open lower today as well, following Friday's down day on the Dow. It could be quiet in Asia today with American markets closed on Monday for the Memorial Day Holiday (which also kicks off the summer driving season, whatever that actually means). Also, keep in mind that the big rally since mid-March may simply have run out of steam.

But if the "carry trade" isn't carrying the Aussie dollar higher, what is? Well, it could be the appeal of a "commodity currency." Gold closed over seven bucks higher in Friday trading to close at $958.90. Oil was up one percent, too, to $61.70. Saudi Arabian oil minister Ali al-Naimi told reporters in Rome that oil would hit $75 when global demand picks up. Perhaps the minister has read our "Long Aftershock" report!

"We'll get there eventually," al-Naimi said. "The trick is keeping it between $70 and $80. It will be achieved as demand rises and the fundamentals are better than they are now." We're not exactly sure what 'fundamentals' al-Naimi has in mind. The one we have in mind is supply. Don't be surprised if global oil demand rises a lot faster than the capacity of oil companies to increase supply.

Some national oil companies-especially PEMEX in Mexico-are watching their major oil fields experience big declines in production. The Cantarell field, for example, used to pump out around two million barrels of oil per day in 2004. Today, it's just 700,000 barrels per day. That decline is a result of under investment by PEMEX and simple resource depletion.

When you combine the huge fall-off in capital spending by the oil companies with declining production from the world's major fields, and then add in the possibility of a swifter recovery in demand than investor's expect, you get a higher oil price. And don't forget inflation. The weaker U.S. dollar will put a little in wind oil's sails as well.

Dan Denning
for The Daily Reckoning Australia

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