Opportunities in the US credit downgrade

I was on BNN last night – here is the link to the entire episode – and noted that two of my three top picks were gold producers.  Immediately after my show, Fitch had a surprise downgrade of the US Government after the close on Tuesday. Fitch came out after the close and cut the US credit rating from AAA to AA!

To me, this announcement adds fuel to my reasoning behind buying gold producers.

Fitch says its downgrade “reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions”.

Let’s take a look at a couple of thoughts on how the US Fitch credit downgrade might be traded. We’ll look at gold, and the potential for a direct currency trade. Lets get started.

Gold

To start, gold has a negative correlation to the USD, as I noted noted on the show yesterday. For more insights on gold, You can review my July 15th video here on why I like the producers. You can also listen in on Brooke Thackray & I discussing gold here.

Memories of 2011 – when gold was a large winner

Fitch’s move follows a similar cut by S&P about 12 years ago. Moody’s continues to rate the US AAA. Credit downgrades can affect currencies. Any pressure on the USD can boost gold.

Here’s the 2011 move on gold:

 

Here’s the gold producers in 2011. The bigger move was on bullion, the less volatile play was in the stocks. Both had nice pops. Note that they didn’t last. Clearly, traders would have benefitted by that move. Investors, not so much.

 

The USD

Here’s the USD chart in 2011 surrounding the downgrade.

 

Investors who traded (and I mean traded, aka not invested in for a meaningful period of time…) the inverse USD ETF (UDN-US) in 2011 did ok. See the chart below. Of note: If the C$ outperforms the USD, then buying this ETF (which is issued in USD & trades in the US) within a C$ account will not be as profitable.   Traders would be better off buying the UDN shares within a USD denominated account to hedge their currency, or take the trade in US  currency. KEEP IN MIND THE RISKS OF INVERSE ETF’S. They are best used in moderation, and with a sharp eye on stops and target sell points.

 

Here is the USD chart going back 20 years to now. Note the test of former resistance, which is now support. It’s sitting at around 102 as of yesterdays close. A meaningful break lasting more than just a few days could push the index back to old support near 92. That is to be seen. If such an occurrence materializes, look for big opportunities in currencies and gold.

 

Conclusion

Its best not to bet against the greenback for anything more than a trade. In my opinion, the potential for either a sideways or weakening USD trend is good, although it may not last too long. We’re likely talking a few months at best. But, the opportunities could be big for that play.

Regarding the inverse trade noted above, beyond a USD account, I personally wouldn’t try to play the currency game too aggressively. Inverse ETF’s are fine as hedges, but they can backfire if things don’t work out as expected.

I’m more interested in the gold trade, and I do hope you were paying attention to my past blogs and videos on that subject. If you have not already followed my suggestions on buying gold from my past blogs, you might want to keep an eye for an opening.

 

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