Some Pros Say Buck Is Overdue for a Bounce. Not Me

I CAN'T PROVE THEY'RE the same bunch, of course, but the-dollar-is-done-falling people remind me of the $50-crude-is-unsustainable people from a couple of years ago. It was unsustainable alright, just not in the way that all the smart contrarians were expecting.

On the eve of April Fool's Day in 2005, a Goldman Sachs analyst issued a report suggesting that crude was in the early stages of a "super-spike" that could top out at $105 barrel. The reaction ranged from somewhat skeptical to insultingly incredulous. There were mutterings about how much Goldman, the leading energy trader, might have to gain from the far-out call by its analyst. There were suggestions that Goldman had unwittingly called the very top of the commodity bull market.

One trading pro called the report "this asinine projection." A rival analyst was almost as rude in print: "Put together the right set of parameters, no matter how unlikely they might be, and you can generate any higher price you care to mention."

So here we are 32 months later and at 90% of the predicted maximum for the super-spike. (That ceiling subsequently got revised to $135 a barrel, and please, God, let's not go there.) For all I know crude never gets to $105, though this seems unlikely. Or maybe Hugo Chavez is not even half-crazy when he daydreams of $200 a barrel following a U.S. attack on Iran. For the record, the Goldman analyst who made that call now sees $80 a barrel by April, and it's a sign of how much the world has changed that this is now what passes for bearish. In fact, oil futures bottom just south of $82 for crude delivered in mid-2010, though who knows exactly how much the dollar will be worth by then.

The point is, there comes a time in every trend when many jaded and professional observers begin to see a turning point ahead, because, well, because one always comes along eventually, doesn't it? These gutsy calls are usually premature for the simple reason that turning points in extended trends are hard to spot. When trying to pick a point on a trend line, the chance of being wrong is very strong. Give me blackjack odds any day of the week.

So why do so many bright people like to call market bottoms and market tops? I believe that some of it is about subconscious bias and naked self-interest. Take that Goldman analyst — a lot more people know about Arjun N. Murti now than did before he called $105 a barrel and supersized his spike. One doesn't get noticed much for regurgitating the consensus. Besides, how much fun is that? These guys are intellectuals, they want to say something other than "buck is going down," whether serving up morsels of wisdom on "Power Lunch" or sharing unique insights with clients.

So a consensus barely has a chance to form these days before the smart crowd turns on it as viciously as a high school clique. Now I realize that the dollar has been losing ground for six years now, but it wasn't until late August, when it decisively underperformed its late-2004 lows, that talk of a full-blown currency crisis kicked in.

So here we are barely two months into an accelerated decline that can only be described as a rout, and all the smart guys figure the buck is overdue for the bounce. I've heard several analysts say in recent days, as Jason Trennert of the Strategas Group did on CNBC Friday, that with everyone expecting the dollar to go down he wants to be on the other side of that trade. Longtime dollar bear Jeff Saut of Raymond James has also just called the trend played out, at least temporarily.

"Whenever there is a strong consensus that something will occur, it's time to get cautious," The Wall Street Journal's personal-finance columnist, Jonathan Clements, advised his readers on Sunday. "After all, if everybody is already betting the dollar will fall, that raises the question: Who will do all the additional selling that drives the dollar lower?"

That's an excellent question that deserves to be asked during extended market moves: With so many speculators flocking to one side of the trade, what are the odds that it can keep going? And the answer often is that it can because the speculators are merely balancing a known market imbalance.

For example, the rush of investment funds into energy futures is often cited for crude's rapid rise, sometimes with the implication that the oil price has stopped reflecting some sort of fundamental economic reality. But speculators are not extraneous to the economy, as if they were aliens from Mars. They're more like Adam Smith's invisible hand personified, amplifying the price signals that serve as essential economic messengers.

Speculators are "long" oil because every oil consumer is "short." They're long because investment in oil exploration and processing infrastructure hasn't kept up with demand. They're long because so much crude lies buried in difficult, tense or just plain hostile places. They're long because India and China subsidize their people's growing thirst for fuel, while rich country consumers are still rich enough not to kick up too much of a fuss about $3 a gallon unleaded.

So when Clements asks who will do all the additional selling that drives the dollar lower, the answer could well be the same people who've been doing it this fall: the Chinese and the Arabs with more dollar-denominated export earnings than they currently deem prudent to hold in the world's formerly dominant currency. In 2007, the U.S. is still importing some $700 billion more in goods and services than it exports; last year's even larger gap was covered by foreign investment.

But foreigners' demand for U.S. assets began to flag this summer as the credit markets cracked, while Americans' urge to diversify overseas has only grown. More than $100 billion poured into U.S. mutual funds that primarily buy shares abroad during the first nine months of the year. According to The Wall Street Journal, overseas investments have accounted for more than 95% of all equity fund inflows.

Why such a rush? It's not just that overseas markets have posted superior returns for several years. It's also the fact that, through March, only 21% of equity holdings in U.S. retirement accounts were allocated overseas. Meanwhile, U.S. stocks now account for less than a third of global stock market capitalization by value. So the vast majority of U.S. investors remain dangerously overexposed to U.S. equities given New York's shrinking share of the global pie.

Here's who else could be selling some dollars in the months to come. It could be foreign governments that have accumulated $2.4 trillion in official currency reserves, or it could be foreigners who've stockpiled some $366 billion under overseas mattresses, accounting for nearly half of all the U.S. currency in circulation.

Momentum is velocity multiplied by mass, and velocity is a function of how long an object has been falling, at least until its velocity becomes terminal. There are a lot of dollars around the world, partly because the currency used to be an unrivaled store of value. Now it's not only rivaled, it's been dramatically weakened against just about any alternative.

It would be convenient to think that in these circumstances the dollar can come down just enough to cure the U.S. current-account deficit but not so much as to become the butt of jokes in a multitude of foreign languages. But prices exhibiting lots of momentum tend to overshoot expectations. The greenback's exchange rate should prove no different.

For all the hand-wringing and hair-pulling about the dollar, the current account gap is on pace to shrink only by 12% or so this year. For all the carping about the $95-a-barrel oil, stock buybacks by energy companies continue to outpace investments in exploration. Until these fundamental imbalances correct, season contrarian predictions with plenty of salt.