Is the Greenback Toast?

What a difference a few short weeks makes. Precious metals, which got chopped to pieces in July and August, are now firing on all cylinders. Gold seems to have broken out of a long triangle that started in mid-2006, while the U.S. Dollar Index is testing its lows around 80.

This very long-term support level for the greenback goes way back to the 1990s. The area around 80 has been a floor for the U.S. dollar four previous times since 1990. So any decisive break here would pretty much signal Armaggedon for the buck and of course big potential gains for some commodities like gold.

So what’s the prognosis from the latest Commitments of Traders report issued Sept. 7? Looks bad for the dollar. Last Friday’s COTs report issued by the U.S. Commodity Futures Trading Commission didn’t change my bearish signal for the U.S. Dollar Index.

While the latest COTs data shows the “smart money” commercial traders have been super-long the U.S. dollar since March, the commercial net position hasn’t been at any kind of historic extremes that would warrant a flip to a bullish signal, according to my studies of past futures data.

My trading system built around the COTs reports has been bearish the U.S. dollar since last Oct. 2006. That was when the dollar peaked around 87, and it’s been sliding ever since.

I think the data for the U.S. dollar underlines the importance of looking at the long picture when trying to analyze the COTs reports. Many analysts and stories in the financial media report on the week-to-week fluctuations of this fascinating, free government data. They suggest that just because derivatives traders slightly increased their net positions one way or another the underlying market will move accordingly.

I used to read such stories intently, but after looking closely at the COTs for myself I grew more skeptical. This was because I actually studied the COTs to see if I could find week-by-week correlations with subsequent prices in the following several weeks and months. I found nothing of any significance. To my knowledge, no one else has either.

The U.S. dollar is a prime example. Commercial traders have held highly bullish-seeming net percentage-of-open-interest positions for several months. Meanwhile, the greenback has all but fallen off a cliff. Does that mean the commercials are in fact the “dumb money”? Does it mean the COTs “don’t work any more,” as some folks suggest.

No. I think it just means the recent positioning has to be put into the correct longer-term perspective and matched against past extremes in the historic data that signaled high probabilities of coming changes in the markets. Good luck in your trading and investing.