In my last column, my predictions for 2010 (or at least the first part of it) were that both the stock market and commodities are destined for a fall, and that the dollar is the only major asset primed for a significant rise. This generated such reader comments as...
 

• "I believe commodities are the thing for 2010. The dollar continues to give ground. I say you are WRONG in your prediction."
• "... based on the U.S. govt's incredible spending, there is a likelihood that gold will be the one to go up, not the dollar. The government has to devalue it to pay for everything it wants to pay for. I would say you are off base."
• "As long as the U.S. spends like drunken sailors, the dollar will get weaker and weaker. Continue to short the dollar. Gold is in uncharted territory but will remain the safest harbor until there is a change of government policy."
• "I am inclined to agree with the majority of your prognostication with the exception of the U.S. dollar strength. I cannot see how the USD can gain strength because the Administration/Federal Reserve has increased the money supply out of proportion to its intrinsic value."
• "Can the dollar gain strength with all the printing presses going full speed ahead?"

There is some merit in all these comments, of course. But what matters in the markets is...

a) Perceptions of those looking to invest, and

b) Value of a given asset relative to others

Before I start in on those topics, let me state the following:

I do believe that longer-term the U.S. dollar and, for that matter, any paper currency is ultimately going to go the way of the Confederate dollar before this crisis is over.

In fact, I think what will eventually draw a line under the worsening economic climate will be an announcement by a major country/region that they will be backing their currency with gold regardless of what the IMF or the rest of the world's central bankers have to say about it.

That said, it will be a while yet before any of this comes to pass. Whoever is brave enough to try such a bold move will probably have to be armed to the teeth. Otherwise they won't be able to forestall a military-based attempt at a "currency attitude adjustment" from the followers of paper currency. There is no way the followers of paper currency will give up the ghost without an all out knock down barroom brawl.

The only country strong enough to do such a thing at the moment is the US of A -- and our government is one of the least likely to endorse the fiscal responsibility that gold backing enforces upon a currency regime.

In fact, the U.S. government is going to be the most aggressive at trying to prove the supremacy of paper dollars over gold.

For the next little while they'll probably succeed. Take a look at the GAP between the current gold price and its 50-week moving average and you'll see why:

The last time the gold price raced up past that 50-week average (and peaked in both the Stochastics and MACD indicators) it first stagnated and then corrected fairly sharply.

The weakness lasted for a good 10 months. Of course there's no guarantee that the same thing will happen again but any time any asset "runs away" from its moving average there is going to be a period where it loses power and momentum and allows its moving average to catch up to it.

So where's gold going then?

Considering that gold finally stabilized at a level of previous resistance the last time around ($700 in October 2008) it's fair to project that a similar drop would level off at the $950-$1,000 mark a few months from now. That would be roughly where the 50-week moving average sits at the moment (or perhaps even a bit lower than that).

Based purely on fundamentals and what we know of the printing presses, deficits, fiscal irresponsibility and so forth – this sounds absolutely preposterous, doesn't it?

But the charts are hinting rather strongly that it will happen.

Here's the latest chart of UUP (the PowerShares DB US Dollar Index Bullish Fund):

The volume spike I talked about in the last column is tailing off and right now UUP is overbought on the Stochastics indicator. However, the very heavy volume at the bottom would indicate that some very serious players are betting on a significant rise in the U.S. dollar.

What do they know that we don't?

Probably that the U.S. government is going to throw everything it can at the dollar in the next little while because they have to persuade the world that U.S. debt is a good thing to buy and hold.

After all, a massive amount of debt is going to have to be issued this year to cover the widening deficits the government is trying to fund. Without a (perceived) strong dollar there's no way that debt is going for anything less than fire sale prices.

That's would be a disaster the government and its backers really don't want to even begin to contemplate, so they're going to throw all the financial weaponry at it as they possibly can.

How long they can keep it up remains to be seen, but you can bet that it will be for a few months unless the U.S. government has truly lost its influence (I don't think it has, even though it's weaker than it once was). Don't forget that the USA is still a major financial power and there are enough parties with vested interests (i.e. current U.S. debt-holders) who aren't about to stand in their way.

Why not? Well, let's say you're holding a whole bunch of dollars right now that you'd love to get rid of.

Don't you think it's likely that the Chinese -- amongst others -- might just use a U.S. dollar rally to begin dumping part of their USD holdings? They're not going to squelch a USD run that facilitates such a dump that also cheapens something they'd much rather be accumulating: gold.

And even if they're not truly hardcore gold bugs, a lot of other non-USD alternatives will get cheaper too. Take a look at the dollar's main paper rival – the Euro has some problems of its own...



Just like gold, the EUR collapsed by quite a ways once it decisively broke through its moving averages after a MACD crossover (red arrow). A very similar situation is developing today, just as with the gold chart.

So are the Chinese truly looking to accumulate a few extra Euros too? Well, we won't know for sure until after the fact -- but Euros are likely to go on sale for a discount in the next few months.

Bear market rallies can be brutal

The USD is therefore looking quite tempting for those looking to profit from a bear market rally – which is exactly what this is when you look at the longer-term historical picture of paper assets vs. hard assets in a financial crisis.

The rally won't last forever.

But when you see how successful "The Powers That Be" were at ramping up the stock market last year, there's no reason to believe that they won't pull out all the stops to do the same for the dollar this year.

It's much tougher to manipulate the forex markets than the stock market, but as you're probably aware, we're living in an era of unprecedented government interventions in the free markets. And there are a LOT of vested interests that would love to see a dollar rally this year -- even if it means stocks and most other paper currencies take it on the chin for now.

The elephants are leaving some pretty big footprints, and those footprints are telling us that the USD is going to demonstrate real strength at gold's expense in the short to medium term.