KING $DOLLAR: GLOBAL DELEVERAGING HAS BEGUN!

The Dollar appears to have had an early four year cycle low in May and has since commenced to surge much higher.  It looks like the dollar wants to break out of its multi-year basing pattern since its low in 2008.  The dollar could be rising because we are the best house in a bad neighborhood or because deflation is beginning to overwhelm the central banks.  I believe a great deflation is commencing as the Fed withdrawals its liquidity from the markets: Commodities are collapsing to the downside, precious metals are hitting multi year lows, bonds have been ripping higher since December, emerging stock markets (EEM) are testing August lows and the Russell 2000 (IWM) peaked on July 3 and is now negative on the year.

A strong dollar is a sign of the Fed losing its battle with deflation.  In my opinion it is only a matter of time before deflation overwhelms the major US stock market indices.  Additionally many emerging market countries have issued much of their debt in Dollars.  A strong dollar is a complete disaster for emerging markets!  As the dollar appreciates it will increase the debt burden of these countries and this will cause their currencies to come under pressure.  This will in turn force levered carry trade players to sell emerging market debt and thus a virtuous death spiral will have begun.  As this leverage begins to unwind it will have knock on effects and we should see increased volatility in all risk on assets.

In our debt based fiat currency system it is important to remember money=debt.  The Fed is withdrawing credit from the system (QE is direct money injections).  Less debt/credit in the system means less dollars in the system and thus a bid for Dollars.  Once the reflexivity process begins it will feed on itself.  Margin calls and defaults are around the corner which will cause the dollar to rise further and in turn screw the emerging markets some more.  I am predicting the Dollar (DXY) likely rises 20-40% over the next 2 years.  In the very short term I am expecting the Dollar to pause and perhaps pull back before ripping higher.

Of course the Fed could announce QE 4 and try to prevent this from happening.  However, they know that QE is producing diminishing returns and they need to reverse the decrease in foreign purchases of treasuries.  We are currently in a financial war with Russia and China that may turn hot at some point.  A strong Dollar would crush Russia and put a dent in all their de-dollarization efforts.  I have no doubt that the Fed would choose funding the government over the health of the stock market all day long.  The belief that the Fed has your back will soon be put to the test.

Fun Fact: we have a confirmed Hindenberg Omen signal on Friday.  While not foolproof, it has historically generated a 25% chance of a correction greater than 15% between the date of signal and 4 months out.

I am still long my IWM 110 December puts that I put on at the end of August and September 4th.  If you own the emerging markets or anything with exposure to emerging markets I would urge extreme caution.  In my opinion the pain is just beginning there.