A Strong Dollar World

James Juliano Insights

Weakness in commodity prices has been making headlines since oil prices fell in half last summer from $106/ barrel in June to $49/barrel today. Stories highlighting the subsequent collapse in the Russian economy where GDP is highly levered to oil exports have followed. But Russia is not the only country hurt in a world of falling commodity prices. Another country’s stock market has been crushed due to its reliance on commodities. While Russia is getting all the headlines, Brazil’s stock market has fallen 37% since September.

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To understand the reason why, we must look back further than last year. Brazilian and Russian stock market weakness began long before last summer’s oil crash. Let’s look at gold to tell the longer story.

Gold prices tell us much about the world. The most important thing gold reveals is the strength or weakness of any currency being priced in gold. When most people look at a chart of gold, they see the price of gold fluctuating up and down, “zigging and zagging” over time. This interpretation is incorrect. What you are really viewing when you look at a gold chart is the price of the currency moving around. We can price any currency in gold terms, but let’s focus on the US$. When gold priced in US dollars goes up, you are actually seeing the value of the US$ decline. When gold priced in US dollars goes down, you are actually seeing the value of the US$ increase.

Gold prices rose consistently from 2002-2011, when they peaked near $1,800/ounce. This means that the US$ was losing value for most of the 2000’s. A shift occurred in 2011-12. The US$ stopped losing value (evidenced by gold prices that stopped rising) and then the US$ started gaining value (evidenced by gold prices that fell.)

From 2011 to present the US$ has increased dramatically in value with the price of gold falling 33%. The chart below shows this evolution from a weak US$ to a strong US$. It shows a long term trended average of gold priced in US$ to smooth volatility.

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The direction of the value of the US$ has enormous impact on the price of other assets. US$ strength or weakness influences what kinds of stocks, bonds and real estate perform well. Importantly, the value of the US$ has an enormous impact on the price of commodities. This is very meaningful for emerging market countries that are heavy exporters of commodities, i.e. Brazil and Russia. The value of the US$ and its impact on commodity prices is a large driver of the Brazilian and Russian economies and their respective stock markets. Not surprisingly, since gold prices peaked around $1800/ounce in 2011, the Russian (purple line below) and Brazilian (red line below) markets have fallen 54% and 50%, respectively. These returns are almost identical. While only Russia has been engaged in geopolitical conflict with Ukraine and punished with large global sanctions, Brazil has performed just as poorly because a strong US$ is helping capital flee both destinations.

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