2010: Not Bad For The Dollar (UUP, UDN)
Traders and investors who believe the U.S. economy is in a death spiral shouldn’t be in a rush to short the dollar. After all, better plays were there in 2010. Make that two better plays.
Before delving into that, though, let’s consider the dollar’s current position. The greenback, for better or worse, is still the world’s “go-to” currency. Although the U.S. currency’s hegemony has been chipped away by the euro over the past decade, the buck is still the dominant reserve asset. This year, in fact, worldwide dollar holdings have held steady, while reserve positions in the European common currency have slipped a bit. As of year-end 2009 and through the first half of 2010, the dollar took up 62.1 percent of central banks’ allocated reserves. In 2010, euro allocations fell 0.9 points to 26.5 percent.
Percentage Of Worldwide Allocated Reserves
There’s a subtext here. Over the past few years, central banks have sought to diversify their reserve holdings to better manage risk. In 2008 and 2009, in particular, dollar allocations were the primary “feeder” of these alternative positions. In 2010, however, it was the banks’ euro allocations that were reduced to bolster nondollar currency positions.
USDs Vs. SDRs
Obviously, the dollar’s not without its problems. Testimony to that came just last month when the International Monetary Fund’s special drawing rights (SDRs) were reconstituted.
The SDR is an international reserve asset, originally created by the IMF to facilitate member banks’ currency trading. SDRs can be exchanged for freely tradable currencies to settle claims between IMF members.
The SDR’s value is based on a basket of four key currencies—the U.S. dollar, the euro, pound sterling and the Japanese yen. The weights of the currencies in the SDR basket are reviewed every five years to ensure they reflect each issuer’s export values, and the amount of the issuer’s currency is held as reserves by other IMF members.
Apparently, the IMF has taken into account a five-year decline of 4.4 percent in dollar reserve positions in the latest reconstitution. On Jan. 1, 2011, the dollar’s weight in the SDR will be whittled down from 44.0 percent to 41.9 percent, while the euro gets a bump up from 34.0 percent to 37.4 percent.
Special Drawing Rights Composition
|U.S. Dollar (USD)||44.0%||41.9%|
|British Pound (GBP)||11.0%||11.3%|
|Japanese Yen (JPY)||11.0%||9.4%|
The Dollar Vs. Gold
One of the easiest ways to measure the strength of a currency is to compare its value to gold. You can quickly detect debasement if the currency-denominated price of gold appreciates at a faster pace than that of other reserve assets.
While the greenback was beat up by bullion in 2010, the euro and pound sterling actually suffered worse drubbings. These were, in fact, the shorts of the year.
For the 12 months ending Dec. 21, the European common currency lost 34.8 percent to gold. The dollar, at the same time, yielded 23.0 percent to bullion. Meantime, the pound gave up 28.5 percent.
Since the launch of the euro in 1999, the “race to the bottom” has actually been led by sterling. The pound’s value has eroded at an average annual rate of 15.4 percent compared to bullion, while the dollar and the yen are neck-and-neck for the second- and third-worst performance.
Reserve Currency Performance Vs. Gold
(01-Jan-99 through 21-Dec-10)
|High Gold Price
|Euro (EUR)||-34.8%||-13.6%||1,065.35 (08-Dec-10)|
|British Pound (GBP)||-28.5%||-15.4%||901.08 (08-Dec-10)|
|U.S. Dollar (USD)||-23.0%||-14.8%||1,420.21 (08-Dec-10)|
|Japanese Yen (JPY)||-11.5%||-14.6%||117,563.00 (08-Dec-10)|
|Swiss Franc (CHF)||-13.8%||-11.3%||1,441.97 (08-Jun-10)|
Prices reflect average of daily ask side for interbank transactions
Gold Priced In Reserve Currencies
Long gold/short currency arbs featuring the euro and pound are likely to remain stand-outs in early 2011.
The Final Tally
Based on what we’ve seen, there actually seems to be consensus on the dollar. On the one hand, central banks still favor the dollar as a reserve asset and seem disinclined to drop their allocations further.
But then there’s the IMF’s relegation of the greenback to a lighter weighting in the SDR. That’s actually an artifact. The five-year downtrend in central banks’ dollar allocations may be checked now as the euro wobbles and reels from one debt crisis to another.
Lastly, we have the dollar’s performance in gold terms. Clearly, an average annual loss of 14.8 percent isn’t worth crowing about. Still, it’s not as bad as a yearly 15.4 percent nick.
Related ETFs: PowerShares DB US Dollar Index Bearish ETF (NYSE:UDN), PowerShares DB US Dollar Index Bullish ETF (NYSE:UUP).
All told, things could be worse for the dollar.
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