Commodity Currency Risk Looms

As a new RealMoney contributor who will be focusing most of his efforts on non-dollar investments, I felt it important to lay a little groundwork by discussing the current state of the U.S. dollar and potential currency pitfalls to watch out for in '06.

Everyone knows that the Dollar Index surprised almost everyone in 2005 by rallying more than 12%, providing a classic example of contrarian investing.

However, the simple "dollar rally" headline masks a more complex underlying global currency story: While the dollar rallied strongly against the yen, euro and pound, it scarcely budged against the currencies of Australia and New Zealand, which posted small single-digit percentage declines, and Canada, which actually registered a small gain of 2.8% for the year vs. the U.S. dollar. And these "commodity currencies" face outsized risk in 2006, a year that I expect will see the dollar continue to rally in the face of continued skepticism.

Dollar Skeptics Abound

Despite the rise in the U.S. Dollar Index last year, there remains a very healthy dose of skepticism toward our currency. I'm not talking here about the dollar permabears who, though they aren't technicians, declared this year's rally dead on a technical basis in August and did so again in recent weeks when the dollar backed away from its November highs.

However, as can clearly be seen, the dollar's trend over the last year has been orderly and remains intact.

U.S. Dollar Index The orderly ascent continues

Source: Stockcharts.com

To declare the dollar's run finished on any technical basis seems a stretch at the moment. Perhaps it will indeed top out at this level, or perhaps it will top if the Fed pauses its tightening campaign while the European and Japanese central banks continue raising rates and close the interest rate gap, but that clearly remains to be seen.

The more interesting technical story has to do with something that can't be viewed on the chart above: the state of market sentiment toward the dollar. Despite its rise in 2005, a general mistrust of our currency remains.

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Charles P. Hanlon focuses on non-dollar investments. He is currently the president of Delta Global Advisors. At the time of publication, Hanloni had no positions in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Hanlon appreciates your feedback; click here to send him an email.