Confounded by the US dollar

For example, the Dow Jones index is back at a new record high. The market is saying that the economic outlook is fine, profits look strong and US companies should be more highly valued than ever in their history.

But is the market right? Ask almost anybody who had been reading the newspapers over this summer whether markets should be higher than in June, and even the most humble reader could be forgiven for being skeptical.

What about the global credit crunch? What about the huge losses now being reported in the banking and financial sector? What about the vanishing hedge funds? What about the US house price slump that looks to be rolling into a global real estate downturn?

Panic attack

How long will it be before one small investor yells 'fire' and everybody rushes to get out of stocks? Logically we are talking weeks or months at the most. Just a few bad economic reports might be enough.

Now the position of the US dollar in the current financial crisis is well documented. The greenback has taken the full impact of the devaluation of US non-property assets relative to other markets.

But when the US stock market crumbles then this process will be thrown into reverse. The US dollar will surge in value as investors liquidate their portfolios and effectively buy US dollars. This is not a guess, it has been the pattern in every minor correction of the past few years and the effect will just be bigger in a stock market crash.

Buy the US dollar

So does the bold investor buy US dollars now and sit on the sidelines? Not really, the bold investor plunges into US stocks and gets his head shot off in due course! It is the safe investor that will buy the US dollar at a time when it seems friendless.

Remember successful investing is about buying cheap and selling dear. So sell US stocks while they are unsustainably high and get into the unloved US dollar.

The technical charts point to a double top in gold and a double bottom in the US dollar, and that should also be a message to anybody searching for support in behaving in this entirely logical and sensible way.

Cash is king

Actually if you think a stock market crash is likely, and privately few investors now discount the idea while strangely risking their money in such treacherous markets, then you should go into cash whatever you think will happen to the US dollar. For once markets go down then what you will need is cash to buy cheaper shares, no matter what the US dollar is worth against other currencies.

Now there is an argument doing the rounds that China will ride to the rescue of the US and buy out the entire stock market with its financial reserves. But if you believe that kind of nonsense then you should stick to a deposit account for your own good. China is going to suffer a far worse financial crash than the US with its massively overvalued and vertically driven stock market.

See also:
Marc Faber: Considerations for gold investors, tech stocks and emerging markets
DailyFX Currency Update
Gold: is the sky the limit?