2012 U.S. Dollar Outlook: How To Play A Short-Term Rally In The Currency (UUP, UDN, TBT, TLT, GLD)

Larry D. Spears: The U.S. dollar (NYSEARCA:UUP) will start 2012  on an upswing – but don’t let it fool you.  What we’re seeing is only a short-term rally inspired by Europe’s travails. In the long-term, the U.S. Federal Reserve‘s loose monetary policy and the United States’ own debt burden will drive the greenback back down.

That’s the consensus among experts who follow the global money markets and the leading currencies, including several of Money Morning’s own  analysts.

“The dollar is going to rally in the short-term so long as the primary  liquidity mechanism (used by the world’s central banks) continues to be dollar  swaps,” said Money Morning Chief Investment Strategist  Keith Fitz-Gerald. “How long that is going to last is uncertain – perhaps  March, April or beyond – but once it abates, our own enormous debt problems and  inflationary policies will return to the spotlight and the dollar will quickly  give up its recent gains.”

Indeed, the dollar rallied in the second half of 2011, as Europe’s debt battle dominated the headlines. The U.S. Dollar Index, which measures the dollar’s  value against a basket of foreign currencies, ended about 10% higher than its  May 2011 lows, gaining almost 3% in November.

That momentum is likely to continue for the first part of the New Year, but not long after.

Several economic factors will weigh far too heavily on the currency for the  upward move to continue – although it’s not clear exactly when the short-term surge will lose steam. And investors who understand what’s really driving the  U.S. dollar’s value in 2012 can avoid getting burned by the currency’s  long-term decline.
(Money Map has 2012 forecasts  for more than just the U.S. dollar. In the latest Money Map forecast report  you’ll find profit opportunities for oil and natural gas, biotech, commodities,  artificial intelligence and more. Take a look right here to learn how to get a free download of the complete 2012 Investor’s Forecast Report.)

Short-Term Help from Europe

The U.S. dollar’s short-term boost will mostly come from the  need to support Eurozone governments with more liquidity.

“The ECB (European Central Bank) will be left with little choice in saving  banks and their sorry sovereigns other than to print, print, print euros, and  more of something almost always leads to a lower price,” said CNBC  NewsBrian Sullivan, who thinks the U.S. dollar will  reach parity with the euro in 2012.

The euro fell to a 15-month low against the dollar in the last week of 2011.

U.S. dollar value has also been driven higher recently by  increased demand, since the central banks in Europe, the United States, Great Britain, Japan, Canada and Switzerland have all agreed to lower the interest rates on dollar swaps.

“Dollar swaps – you know, those little arrangements that allow foreign banks to swap their unloved currencies for dollars – … really come in handy when there’s a panic and a flight to the safety of U.S. Treasuries,” Money  Morning Capital Waves Strategist Shah Gilani explained. Since U.S. Treasury securities must be purchased with dollars, increased demand boosts the currency’s value.

However, the overwhelming long-term outlook for the U.S. currency is still  bearish, mostly due to the weak U.S. economic outlook for 2012.

“The dollar is enjoying a safe-haven status, but long run I’m not a fan of the U.S. dollar,” Dr. Allen Sinai, chief global economist at Decision Economics, told Forbes. “Our country has too many problems – with  long-run growth forecasts, deficits and how the politics of our country  operates are all a negative.”

Indeed, the dollar’s prolonged  decline has been supported by the ongoing struggles of the U.S. economy, the  ever-growing levels of U.S. government debt, and the misguided  “fixes” and other monetary and interest-rate maneuvers by U.S.  Federal Reserve Chairman Ben Bernanke and his cohorts.

These influences won’t disappear in 2012.

“The Fed will be obliged to undertake another round of quantitative easing  and it will be a major source of negativity for the dollar,” said  Forex.com Chief Currency Strategist Brian Dolan. “The economy has been so  slow for so long, it’ll force the Fed’s hand.”

The dollar also faces a growing challenge from the Chinese yuan in its  long-standing role as the world’s dominant reserve currency. China‘s been  making strides in turning the yuan into a global currency by increasing its  role in the gold market and facilitating foreign investment in its currency.

The U.S. dollar’s struggles aren’t new, but rather have been a trend for about a  decade. You can see the dollar’s path of decline with the U.S. Dollar Index, a  measure of the dollar’s value relative to a weighted basket of six major  foreign currencies – the euro (58.6% weight), the Japanese yen (12.6%), the  British pound Sterling (11.9%), the Canadian dollar (9.1%), the Swedish krona  (4.2%) and the Swiss franc (3.6%).

US Dollar Slide Since 2003, the index has  fallen 27% from near 110.00 to just above 80.00. It gained 2.9% in November,  but erased those gains in December to break just about even in 2011.

Luckily for investors, there’s a way to play both the short-term rally and the  long-term fall of the U.S. dollar.

Investing in the U.S. Dollar in 2012

To play the dollar’s fluctuating value this year, investors  can use a Forex market contract, futures contracts on the U.S. Dollar Index or  the dollar versus leading individual currencies, or one of the new dollar-based  exchange traded funds (ETFs). For short-term trades, options on either the  futures or the ETF shares also can be used.

Investors who opt to play the currency’s near-term strength must remember to  monitor the events affecting the dollar’s value – a buy-and-hold approach won’t  work.

“Be nimble,” said Money Morning‘s Fitz-Gerald.  “Harbor no illusions about what’s happening. Capture profits as they’re  created by maintaining tight trailing stops, and steadily ratchet them up if  the rally gains steam.”

One of the leading ETF candidates for a short-term bullish dollar play is the PowerShares DB US Dollar Index Bullish (NYSEARCA:UUP). Actually exchange-traded notes  (ETNs) rather than a traditional fund, units are issued in 200,000-share blocks  by a “master trust” that seeks to replicate the performance of the  Dollar Index by holding a combination of Forex contracts, futures, and options.  Those shares then trade in smaller numbers, just like shares of regular stocks,  and the price mirrors the percentage changes in the actual index.

That’s for a short-term dollar play, but you also should plan to profit from  its longer-term decline.

One of the best ways to play the long-term bearish dollar outlook is through  ETF/ETN shares, like the PowerShares DB US Dollar Index Bearish (NYSEArca:UDN). It’s structured the same way as the UUP fund, but the trust  holdings include short Forex and futures contracts and options, combined in a  portfolio designed to move inversely to the Dollar Index itself, but by a  similar percentage.

The alternate way to make a longer-term ETF play against the dollar is to buy shares in one of the growing number of ETFs linked to foreign currencies –  depending on whether you believe that particular currency will benefit from the dollar’s weakness.

Currencies with their own ETFs currently include the Australian dollar, British pound, Canadian dollar, Chinese yuan, euro (NYSEARCA:FXE), Indian rupee, Japanese yen, Mexican  peso, New Zealand dollar, Russian ruble, South African rand, Swedish krona, and  Swiss Franc. Some currencies, like the rupee and yen, even have two funds from  which to choose.

When the dollar falls, investors will need protection for all of their U.S. market investments – and anything else that’s valued in dollars. For ways to  fight the sliding dollar in your portfolio (and a guide to just how bad dollar depreciation could get), take a look at Money Morning‘s latest special  presentation on the U.S. dollar right  here.

A final option for bearish dollar investors would be to open a bank deposit  account denominated in a foreign currency you think stands to appreciate  considerably against the dollar in the years ahead. A popular choice for such  accounts is Everbank (**), an FDIC-insured Internet bank that  offers deposit accounts, money market accounts and certificates of deposit in  both baskets of currencies and those of specific nations, including the euro, yen, British pound, Swiss franc, yuan, Singapore dollar and several other major  currencies.

Related: PowerShares DB US Dollar Index Bearish (NYSEARCA:UDN), PowerShares DB US Dollar Index Bullish (NYSEARCA:UUP), SPDR Gold Trust (NYSEARCA:GLD), ProShares Trust UltraShort Lehman 20+ Year Treasury ETF (NYSEARCA:TBT), iShares Barclays 20+ yr Treasury Bond Fund (NYSEARCA:TLT).

Written By Larry D. Spears From Money Morning

We’re in the midst of the greatest investing boom in almost 60 years.  And rest assured – this boom is not about to end anytime soon. You see, the flattening of the world continues to spawn new markets worth  trillions of dollars; new customers that measure in the billions; an  insatiable global demand for basic resources that’s growing  exponentially ; and a technological revolution even in the most distant markets on the planet. And Money Morning is here to help investors profit handsomely on this seismic shift in the global economy. In fact,  we believe this is where the only real fortunes will be made in the  months and years to come.

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