Dealing With Divergence: The Outlook For 2015 (Part 4 of 7)

What A Stronger US Dollar Means For Markets

Implications of a stronger dollar

What does this mean for you and your investment portfolio in the New Year? One of the consequences of the diverging central bank actions is that it should lead to a stronger dollar. That has implications for the markets, such as downward pressure on both commodities and inflation.

Market Realist –  The divergence in central banks’ actions and global markets’ economic growth will likely lead to a stronger US dollar. The Federal Reserve is poised to hike rates in 2015. It plans to tighten monetary policy. In contrast, the ECB (European Central Bank), the BoJ (Bank of Japan), and the People’s Bank of China are all following expansionary policies to stimulate their slowing economies. The interest rate differential will likely bolster demand for dollar-denominated assets.

Market Realist –  A stronger US dollar (UUP ) puts downward pressure on commodities and inflation. Crude oil (USO ) (BNO ), gold (GLD ), silver (SLV ), and other commodities are affected by a stronger US dollar. The stronger US dollar is one of the reasons for the steep drop in oil prices and the fall in gold prices. Oil prices were down nearly 46% in 2014. At the end of the year, gold prices were down 1.5%. The fall in gold prices also adversely affects gold miners (GDX ). They struggle to break-even. For 2014, silver was down 19%. Copper and platinum suffered annual declines of 17% and 12%, respectively.

The inverse relationship of the US dollar and gold prices can be seen in the previous graph. As the US economy continues to expand, the dollar will likely remain strong in the first half of 2015. Since crude oil’s supply glut probably won’t ease in a hurry, there isn’t a quick fix to the plunging oil prices. Gold and other precious metals will likely face headwinds going into 2015.

Market Realist –  Investors should tread with caution when it comes to commodities. The exception could be palladium. It finished 2014 with an yearly increase of 11%. Palladium prices benefited from the supply shortfall. The shortfall was a result of the Ukraine-Russia conflict. Russia accounts for 40% of the global supply of palladium. The auto sector is also increasing its demand for palladium. This also helped palladium prices. The graph above shows the price performance of the Physical Palladium Shares ETF (PALL ). It tracks palladium prices.