Just when nibbling at a dollar rally started to look safe — bam! The real world of rising risk reared its ugly head again.

Two markets that reflect risk are the stock market and crude oil. The stock market because it’s the quintessential risk asset class. And crude because higher prices threaten economic growth and add to inflation expectations.

Both of these markets can greatly affect the U.S. dollar. Today, I’d like to explain what this risk correlation means for the greenback going forward.

Let’s start with …

A Graphic Tour of the
Dollar-Stock Relationship

The dollar, more than any other currency lately, has been the one most negatively impacted by market risks such as deterioration in the credit market or trouble for the U.S. economy.

You can see this ebbing and flowing of market risk by observing the price action in the stock market. In fact, the dollar and stocks are now moving in lock step. You can see what I mean in this chart:

Okay, so when stocks go up, the dollar goes up. Easy enough.

But that also means when the stock market goes down, the dollar is likely to do the same. And the stock market is now at a critical juncture!

Look at my next chart …

As you can see, the Dow Transport Average (black line) made a new high recently. However, this high was not confirmed by a new high in the Dow Industrials. This is what is called a Dow Theory non-confirmation setup.

If anything, it appears the Dow Industrials could be turning down in a big way. Should they fall below the key support level of 12,715, we could see some real acceleration to the downside for the overall stock market.

Look at the following chart, and you’ll see what I mean:

Important: If the Dow Industrials Break Down,
The Dollar Will Probably Test Its Old Lows!
What’s More, the Action in Oil Confirms This

Should the stock market break down, investors will get nervous again. And that could mean bad things for the dollar. It likely means the dollar will test its old lows.

What’s more, the recent action in crude oil seems to agree with that scenario. Check out the blow-off high in crude oil:

On my chart, the U.S. dollar is inverted. In other words, the spike you see is the dollar going down. I did it this way so you can see how tightly correlated the greenback and oil prices are. When oil goes up, the buck goes down.

So the question now: Can crude go much higher?

Many of the so-called experts didn’t think it would go this high. But yesterday, I ran the numbers on the movement of crude since May 2000, and here’s what I found:

First, in dollar terms, crude has jumped 330% in price since 2000.

Second, in euro terms, it’s up just 155%.

Third, in terms of gold, crude oil has only gone up 35% since 2000. The numbers show that it now takes 0.140 ounces of gold to buy one barrel of oil, whereas it only took 0.104 ounces back in 2000.

What this means: People holding dollars have felt the spike in oil far more than people holding euros or gold.

In my opinion, crude, gold, and other commodities seem to be taking on a “safe haven” aspect.

So, if this trend continues in commodities — and the stock market breaks down — new lows in the buck cannot be ruled out.

I will continue to watch the stock market and crude oil, and refine my outlook for the dollar as necessary. So stay tuned!

Best wishes,

Jack

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Last 5 posts by Jack Crooks

• Only Gold Is Winning the Ugly Contest - February 26th, 2009
• Stocks AND Dollar to Rally in the First Half? Keep Hope Alive - January 6th, 2009
• We’re Bullish on the US Dollar Today ... and Tomorrow! - January 5th, 2009
• Can we rest? Gold may lead the way. - December 22nd, 2008
• A super deal on the U.S. dollar - December 20th, 2008