The dollar, despite widespread pessimism, could stage a sharp rally
While some giant fund managers say that the dollar has no place to go but down thanks to record deficits, a handful of investors with a knack for going against the grain have started to look for a rally instead. As the status quo increasingly counts on a glide down, any surprise -- positive or negative -- could lead to a sharp reversal that would have major implications for investors.
Given the widespread pessimism about the dollar, even long-term bears on the currency like high-profile investor Jim Rogers are now betting a sharp rally is in the works. Rogers, who started the Quantum Fund with hedge fund legend George Soros, told investors Wednesday that he has been buying the greenback over the last few months "because there are too many bears," in the currency.
Rogers said that he expects another leg down as the financial crises escalates and the Federal Reserve finds itself out of ammo, which would cause a sharp rally in the dollar as investors flock to safety.
Rogers' views now put him in roughly the same camp as Robert Prechter, the President of independent forecasting firm Elliott Wave International. Prechter predicted the last market crash, but then turned bullish and predicted that the S&P 500 would rise to its current levels during its lows because the consensus was so gloomy at that time.
Now Prechter is similarly shocked by how bullish investors have become -- an optimism he feels will be shattered in short order as a deflationary spiral kicks in next year. In an interview with DailyFinance, Prechter said he is "very bullish" on the dollar and expects the currency to rise for at least the next year.
Indeed, even as concerns mount about government debt in countries like Spain and Greece, investors now seem to be turning a blind eye to the risks that could be in store. Rattles like Dubai, when investors rushed into dollars, seem like a mere blip.
The dollar's decline seems like such a given that investors are betting against it while buying risky assets as a way to seriously juice their returns, noted New York University economist Noriel Roubini argued recently.
"Investors who are shorting the U.S. dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms," Roubini wrote. "They are borrowing at very negative interest rates -- as low as negative 10 or 20 percent annualized -- as the fall in the U.S. dollar leads to massive capital gains on short dollar positions."
But any turnaround in the dollar would lead to a violent, self-feeding correction as speculators rushed to cover their short positions. And it's not just a catastrophic outlook that could spur dollar buying. A surprisingly strong job report on Friday led investors to pile into the dollar as speculation mounted that the Federal Reserve may raise interest rates sooner than previously expected.
Even barring some sort of shocking development, there are reasons to be skeptical of much lower the dollar will go given the pervasive bearishness. "The headlines this month are all about the weak dollar," Prechter wrote in November. "But they should be about how the dollar is hardly falling any more despite ubiquitous bearish opinion about it."
A rising dollar, meanwhile, would batter risky assets ranging from stocks already priced for perfection, and particularly those in emerging markets and gold. And it's not as farfetched a scenario as the boatload of pundits calling for a fall believe.