Montreal, Canada

In the absence of a major stock market decline or another financial institution blow-up this summer it’s probably a safe bet to start nibbling at foreign currencies again.

The U.S. Dollar Index (see enclosed chart) broke important support levels last month but is now oversold on a short-term basis. Any dollar rally at this stage of the economic cycle should be tepid at best. The economy is stuck in a de-leveraging process that will take a few years to unwind coupled by scant bank lending in an environment of cash hoarding. This is not a macro environment that will boost U.S. short-term interest rates any time soon.

The United States and probably China, to some extent, desire a weak American dollar to boost domestic inflation. U.S. CPI is still contracting and in May declined for the third straight month to its lowest level since 1955. A lower dollar helps to grow inflation – a desperate commodity right now.

This morning, China launched another currency salvo claiming the world should look “for alternatives to the U.S. dollar.” Such utterances won’t boost the buck but instead likely help facilitate a decline. Interesting how China would slam the dollar when she holds about 35% of all Treasury bonds in circulation.

On Tuesday, I began buying small positions for my managed accounts in Canadian dollars and Norwegian kroner. Gold remains 5% of my portfolio for now.

Though I remain cautious about commodities this summer, including oil and gold, I like the CAD and NOK currencies because of their relatively stronger balance sheets; Norway, in particular, smarts a 10.5% budget surplus-to-GDP ratio – the highest among industrialized nations. This compares to rapidly rising or skyrocketing budget deficits across the major economies since late 2007. And Canada, though now in budget deficit, sports a small deficit compared to its overall economy.

What about the euro? The single European currency is probably better than the dollar but not by much. I prefer gold, NOK and CAD.

Several peripheral euro-zone economies are now in deflation and major trading partners to the East are in desperate need of bank capital. I’m still predicting some sort of blow-up in the Baltic Republics or the Balkans this year. Any macroeconomic collapse in these regions will hit the euro and the emerging markets new “bubble” hard.

The precious metals should rally if the dollar continues to weaken. But, like I said earlier, I’m just “nibbling” at foreign currencies here to build fresh positions that are part of a long-term accumulation strategy for my dollar-based accounts. Any sell-off in risk-based assets this summer – highly likely ahead of earnings guidance and a 40% post-March rally – will drive the dollar higher. That’s when I’ll add to my existing foreign currency holdings.

Gold and silver, however, remains hostage to traditional summer weakness in the commodities complex; gold is especially vulnerable near-term because jewelry demand has collapsed and any outflows from gold-related ETFs will drive the price sharply lower. I’m looking to re-enter gold around $875 to $850 and silver around $14.

It strikes me as fascinating that China is denouncing the dollar again. Something is cooking in Beijing and Washington whereby policymakers probably welcome a weaker dollar.

This should be another very exciting summer marked by renewed volatility, especially in the currency markets, which have been largely range-bound for the last four weeks.

Have a good weekend. See you on Monday.