The USD remains stronger than one might think into the beginning of 2009. Between the latest Mid East tensions and general flight to safety it rallied again to 83 on the USDX when it looked like it might crack into the 70's again, the low being 70ish last year, before the USD rallied after April of 08, which caught the commodity and metals complex.

It's hard to say the USD rally last year alone caused the commodity and metals bubble to break, or did the pending world economic slowdown, which caused the speculators to bail out – and/or did the pending economic slowdown then force financial deleveraging on all fronts which flooded money back into the USD as people liquidated?

But, in any case, it's now obvious that there was flight to cash in the second half of 08, and the USD being the major currency still, it ends up being the main settlement currency when there is market deleveraging. So, the USD rallied strongly in the second half of 08 against practically all currencies, except perhaps the Yen which rallied on its own due in large part to carry trade unwinding during all the deleveraging in the second half of 08 too.

Gold spot holds up pretty well though

But, compared to general commodities which took up to an 80 pct bath, or general stocks which took a 40 plus pct bath before recovering a bit recently, gold spot prices held up comparatively well. (I know gold stocks got hit too, but that is a separate issue related to the gold spot price since gold stocks are much more volatile).

So, a very big question is where is the USD going and gold spot price going in 09?

Well, for the USD, we know it rallied heavily against most major currencies such as the British Pound and the Euro. And, will that continue, or hold, or will the USD enter a new phase and again turn down into the 70's on the USDX say by mid 09?

Well, after the world stock sell offs last year, the foreign markets got totally creamed. The prospects of the Western economies turning into a pumpkin pulled foreign markets down drastically. Of course, some are saying these foreign markets are oversold, but I have to say that the prospects of any significant economic recovery in the West is bleak in 09. So what is the rationale for a foreign stock recovery since they are so dependent on exports? A startling statistic that came out recently is that Japan's exports contracted tremendously in 4th quarter 08, for example. China of course is going through the same situation.

Where will flight to safety go in 09, USD or Gold or Euro or?

Some people think there might be an extended world stock rally in 09, but I think we will see worse and worse economic news, and that any stock rally will be short lived. That means there will be ongoing heavy flight to safety forces in 09.

Why the USD rallied in 08

In 08, it's clear the USD rallied for its own reasons – flight to cash, the USD being the major settlement currency by far, and also deleveraging in everything, and thus the USD rallied to most currencies in second half 08. But Gold spot held up very well compared to the general commodity complex or energy complex, both of which are very tied to world economic activity. As we mentioned in previous articles, gold tracked major events in the Credit Crisis that started in Oct 07, spiking when there were new bad developments, and relieving when there were improvements. So, flight to safety benefitted the USD, gold, and US Treasuries (and German Bunds too).

Interesting caveat on the US T bubble breaking

It's said there is a US Treasury bond bubble, but there is an interesting caveat here. First, there is indeed a UST bubble. But the question is, what is driving it, and can it be sustained? I would like to point out there is also, and has been, a Japanese bond bubble since their deflation, and how many years has that lasted with yields at virtually zero?????

I consider the Yen and the Dollar sister currencies in many respects. Well before China emerged as a big story, Japan and the Fed both have closely coordinated policy to support the USD at times, particularly in crises. Now, at the moment, the Yen is strengthening for its own reasons, mainly deleveraging of the carry trade that built up for ten years. But Japan and the Fed support the USD closely. The caveat on the US T bubble breaking is can the US Ts hold their bubble similar to Japan's bond bubble?

USD still a haven?

In any case, the question now arises if the USD can stay the safe haven of choice with all the new borrowing ahead. One thing to point out is that Japan has had this bond bubble practically forever, and gotten away with it. Can the US pull off the same trick, or at least, get away with its own bond bubble for longer than expected?

There is a big difference though between the US and Japan, in that the US savings rate was/is practically zero, where Japan had a very high domestic savings rate. So, that fact alone could indicate that the US bond bubble might not be as sustainable as Japan's. However, the comparison is still intriguing.

Gold still a haven?

Getting back to gold, it has clearly shown since Oct 07 that it remains a safe haven. Gold spot has resisted the general commodity and energy selloff in 08 fairly well. The USD also has clearly remained stronger as markets deleverage, and so have US Treasury bonds. The Yen has risen a great deal in recent months, much to the angst of Japanese exporters who are calling for intervention. The trouble is, there is so much Yen carry out there, that for the BOJ to try to stop that is like standing in the way of a tidal wave of unwinding, if markets everywhere want to unwind, which they are.

And then there is the general issue of the danger the USD is in, because of our fiscal deficits which are exploding. But the other nations too have this problem, as they fight deleveraging in their markets too, with $trillions worth of their own money. So, what might be called competitive devaluation or monetization in all major currencies is underway as well in 09, and that means the USD can still stay stronger than it might.

I guess the conclusion here is to expect that gold, the USD, and US treasuries can remain safe havens in 09, but I do think the US T bond market can pop, if there is a spike in US interest rates (if people tire of buying $trillions of new US T bonds/notes).

And finally, the Euro has some serious issues, for one thing the ECB is also flooding $trillions worth of Euros out fighting their own credit/banking crisis, and the EU is also diving into recession. One would think the Euro would have a chance to rebound, particularly since it dropped so much in 08, and since their central bank is much more restrained on interest rate cuts. But, a rapidly deteriorating EU economy might cancel that out, and the Euro still keep falling.

Anyway, we have these discussions on an ongoing basis in our PrudentSquirrel newsletter, which is published weekly, with mid week email alerts. We invite you to stop by and check us out. We have made a lot of great calls in 08, such as notice the USD appeared ready to rally, in April of 08, and that a subsequent general commodity sell off was ready. Also, that gold may be bottoming several months ago, around early November. And many other calls through the year.

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