US dollar breakdown provides bullish backdrop for commodities

The relative strength of the US dollar has hampered the performance of many commodities markets for more than a year. Not so anymore. The greenback is showing signs of weakness and has now broken down out of the powerful uptrend it established last summer – something which is providing a bullish backdrop for commodities.

As the chart of the US dollar index below shows, the US dollar established a powerful uptrend last summer, rising from $73.42 in August 2011, to $84.10 on 24 July 2012 – a 14.5% gain. Since then however, the greenback has begun showing signs of weakness and last Friday it broke down out of its year-long uptrend, passing through the psychologically significant $80 mark.

A 1 year chart of the US dollar index

A 1 year chart of the US dollar index

Chart courtesy of stockcharts.com

The US dollar index measures the US dollar against a basket of foreign currencies which include the Euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and the Swiss franc. However the index has a significant weighting to the Euro (57.6%), therefore the movement of the index primarily reflects the value of the US dollar relative to the single currency used in the Eurozone.

In many ways the chart above reflects the fact that the US dollar has been one of the main beneficiaries of the Eurozone debt crisis which took a turn for the worse last summer.

In August 2011, European Commission President Jose Manuel Barroso warned that the sovereign debt crisis was spreading beyond the periphery of the eurozone. At the same time the yields on government bonds in Spain and Italy rose sharply as investors began demanding bigger returns in exchange for lending these nations money.

The recent weakness of the US dollar coincided with a reversal of fortune for the Euro as the regions finance ministers pledged to do “whatever it takes” to save the single currency.

However, regardless of why the greenback has begun to slump, as the chart below shows, it’s a situation that is providing a bullish backdrop for commodities.

A 1 year chart of the CCI (Continuous Commodity Index)

A 1 year chart of the CCI (Continuous Commodity Index)

Chart courtesy of stockcharts.com

Since making a bottom on 1 July this year at 502.28, the CCI has risen 16.9%. The CCI is recognized as a major barometer of commodity prices, since it comprises 17 commodities including, cocoa, coffee, copper, corn, cotton, crude oil, gold, heating oil, live cattle, live hogs, natural gas, orange juice, platinum, silver, soybeans, sugar, and wheat.

The bottom line

With additional  from the US central bank looking increasingly likely, the outlook for the US dollar remains negative, something which should continue to provide a bullish environment for commodities, notably gold and silver.

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