A long time ago (the mid 90s) in a galaxy far far away (Western Europe) it was determined that the major economies of Europe needed to become more integrated in an effort to remain competitive with an increasingly ascendant United States. There was a need to increase the mobility of labour within European countries - while an Oregonian may be willing to relocate to South Carolina in pursuit of economic opportunity, it is far less likely for a Belgian to relocate to Italy or an Austrian to move to France (cultural and linguistic reasons tend to dominate) - and reduce the restrictions on the trade of goods and services. It seemed to make sense that in the pursuit of unity it would be necessary to harmonize interest rates and create a single currency. With that in mind, the Euro was born on January 1, 1999 and became the national currency of most of the major economies in Western Europe (with the notable exceptions of the UK and Switzerland)... finally you could tour the Louvre, the Colosseum, and the Heineken Brewery (strongly recommended!) without having to pay exorbitant fees to currency dealers every few days... ah travel bliss, thy name is Euro. With much fanfare the Euro made its debut and over the next two years... it was a total disaster! Like an overhyped IPO the new currency was at its peak (1.1800) the day it was unveiled and then went on to lose close to thirty percent of its value versus the dollar over the next two years. Europeans were up in arms with this decline in their wealth and Americans went shopping. But a funny thing happened on the way to the great currency graveyard in the sky (residents include the Zimbabwe Dollar, Turkish Lira, Argentina Peso), it sprang back to life. Perhaps invigorated by the anti-climactic nature of the Millennium Bug, the Euro proceeded to rally close to 90% between late 2000 and July 2008... WOW! OK, you say, that's an interesting history on the origin of the Euro, but what has it got to do with me? Well I'm glad you asked. As we see it three big drivers of the ongoing commodity boom have been:

1. Insatiable demand for raw materials from Emerging Economies, namely China
2. The inability of resource companies to meet this surging level in demand with adequate new supply
3. A marked decline in the U.S. Dollar which, given that virtually all commodity markets are traded in Dollars, means that even if underlying demand for commodities is unchanged, prices will rise because they are denominated in a currency that is depreciating in value

Now we've talked in the past about the possibility of a slowdown in China (see Shanghaied in Beijing - July 11th) and we've taken a look at the "death" of the U.S. Dollar and how it's declined against the "wrong" currencies (see "Reports of my death are greatly exaggerated" - U.S. Dollar (with apologies to Mark Twain)), so let's take a look at the flipside of the equation... the rise of the Euro. Over the past year or so the Euro has had a few things going for it: 1) Europe hasn't had the systemic housing meltdown that the U.S. is dealing with, although it has experienced some knock-on effects 2) the European economy has been grinding along at a low, but steady rate of growth, and 3) the European Central Bank's (the U.S. Federal Reserve's counterpart) sole mandate is to maintain price stability (i.e. keep inflation near 2%... which they haven't managed to do for some time). This third point is key because it means that the ECB will continue to keep rates on the high side to try and combat inflation even if growth starts to slow. So over the past several months as inflation has accelerated, the ECB has kept up its hawkish rhetoric, which has kept interest rates high, subsequently attracting flows into Euro-denominated debt, and as investors need to buy Euros to purchase said debt, the Euro has been very strong. Throw in some terrible sentiment on the U.S. Dollar and you've got yourself a recipe for a runaway Euro rally and Dollar plunge. But something happened on the way to the Euro love-in... the economy really started to slip... domestic demand went into recession, exports struggled with a strong currency and inflation started to take a back seat. So what does that mean for the currency? In short, it's probably going lower. The expectation of lower European interest rates will lead to less buying in European debt and less demand for Euros... and conversely, the U.S. Dollar will have a Lazarus-like rise from the dead. Finally, the weak U.S. Dollar (i.e. the gas on the commodity fire) may be about to reverse its trend and take even more wind out of the sails of the commodity story. Let's have a quick look at oil, copper and gold over the past 11 months (the beginning of the most recent surge in the Euro) and on a year-to-date basis. The table below shows the impact of the depreciating dollar on these commodities, most notably for copper where the 22.85% rally since last summer has been largely explained by the decline in the Dollar (82.57% of that move in copper). Similarly since the start of the year, 54.67% of the move up in gold has been due to Dollar weakness. Only 18% of the oil rally has been due to the Dollar, but it has helped there too.

So what's the bottom line? Well, on the way up a weakening Dollar accentuated the commodity boom, and it should have the reverse effect if the commodity complex continues to pullback... which in the short-term seems to be the case (see our thoughts on this sector rotation in And the first one now will later be last, for the times they are a-changin' - Bob Dylan - July 25th)

In other news...

The Olympics are finally here. Let there be world records, stories of overcoming adversity, and of course, corporate shilling. Perhaps lost in this whirlwind of events are the national anthems... those inspiring hymns played for the winner(s) of each event (all cynicism aside, those moments where hard-working athletes stand on the podium while their anthem plays do leave us a little vaclempt). National anthems are a bit of a strange beast however and often have origins and lyrics that are a story unto themselves as our friends at ESPN have pointed out. Of course, few anthems can match the (fictitious) version of the East German national anthem in the movie Top Secret. Enjoy.

Lastly, if you're happy and you know it send an email. We've been writing this blog for a few months now and are keen to hear from you... comments, questions, kudos and complaints are all welcome at advisorservice@frontstreetcapital.com. And be sure to "subscribe" to the blog at the top of the page and you'll receive a link to the blog in your email (for free of course) each Friday as soon as it's published. Thanks for taking the time to make this blog better.