While the factors affecting gold are no doubt nuanced, its popularity is primarily vested in the belief that it represents a stable alternative to the Dollar. Accordingly, as the Dollar fell over the last five years, gold prices soared. Likewise, the ongoing Dollar rally has been matched by a proportional decline in gold prices. However, at least one analyst believes this link could soon break down. While gold is traditionally viewed as a specific protection against US inflation (and the concomitant Dollar depreciation), perhaps its role could expand to offer protection against worldwide inflation.

For example, analysts largely agree that the Dollar rally is as much a product of global economic weakness as of US economic recovery. In fact, the monetary and economic situation in the US continues to deteriorate. But, the global economic situation is deteriorating even faster. By this standard, it is conceivable that the Dollar could continue to outperform its rivals. Meanwhile, it is also conceivable that gold would continue to rise, since the long-term economic picture of the US remains bleak.

Read More: Will gold now move separately from the US dollar and euro?

A (deliberately) leaked report has revealed what investors and analysts have suspected all along: the "Committee to Save the Dollar" is real. Evidently, back in March, when the credit crisis was threatening to spiral out of control, the world's leading bankers were busying themselves preparing a plan to prop up the ailing the Dollar. Their rationale is/was that a more valuable Dollar would do more to relieve inflation (via lower food and commodity prices) and ultimately be easier to implement than a worldwide hike in interest rates. Under the plan, the Central Banks of Europe and Japan would join the Federal Reserve Board to coordinate the large-scale sale of Yen and Euro assets, in exchange for Dollars. While the Dollar's impressive rally has thus far eliminated the need for intervention, the long-term prognosis remains questionable. Regardless of economic fundamentals, however, currency traders may be reluctant to bet too heavily against the Dollar, lest the Central banks move forward with their plan. Bloomberg News reports:

None of this means the dollar won't plunge anew if the global credit crunch worsens. For the moment, though, the need for some kind of Plaza Accord-like currency deal has been reduced.

Read More: `Committee to Save the Dollar' May Not Be Needed

Everyone has a theory to explain the Dollar's explosive rally, which has yet to run out of steam. A recent one identifies a shift in China's forex reserve policy as a driving force. Apparently, in an ostensible effort to clamp down on inflation, the Central Bank of China is resorting to draconian measures. One rule change, which was executed with both speed and lack of media coverage, requires commercial banks to hold a larger portion of their reserves in Dollars, rather than Chinese Yuan. In addition, such banks face new restrictions on foreign debt, which is designed to turn them into net buyers of Dollars. Analysts suggest that this policy represents a roundabout attempt to slow the appreciation of the Chinese Yuan. If they are correct, than surely the Central Bank of China has succeeded, for the currency has virtually ceased in its interminable upward march against the Dollar. This upshot suggests that the goal of the Central Bank was not to fight inflation, but rather to avoid a post-Olympic economic slowdown. The Telegraph reports:

They are now more worried about growth than overheating, and you are seeing that play out in the currency markets. There has been a remarkable change of view."

Read More: Beijing swells dollar reserves through stealth

Even given the Dollar's universally strong performance over the last month, the slide in the value of the Korean Won has been an anomaly, falling over 10% over the same time period and reaching a 4-year low. Analysts attribute the decline to a widening of the country's current account imbalance brought about by a collapse in confidence in Korean securities, namely stocks and bonds. Foreign investors are rushing for the exits in masse, and some are speculating that bonds worth $7 Billion that mature this week will lead to a further outflow of capital. Earlier this year, the Central Bank of Korea spent over $30 Billion propping up the Won, but it has thus far refrained from intervening in the midst of the current slide. At $250 Billion, the Bank's foreign exchange reserves are massive, and it could easily attempt to back up its stern warnings to bearish investors with a large-scale intervention. Thomson Financial News reports:

The government did not intend to intervene in currency markets, the MoneyToday, the online news service, quoted an unnamed official as saying on Sunday. Markets are mystified at the reluctance of Korean authorities to back their words with dollar sales.

Read More: Korea warns currency bears, but shrinks from action

John Taylor is head of the world's largest currency hedge fund, International Foreign Exchange Concepts. Accordingly, when he speaks about currencies, people tend to listen. In an extended interview with Bloomberg News, Taylor noted that volatility has surged in the forex markets. On average, the Dollar is fluctuating 46% more against so-called major currencies and 23% more than emerging currencies, compared to 2007. However, this volatility is largely random- perhaps as a result of increased liquidity- which means inefficiencies in the markets are becoming harder to exploit and profit from. One of the fund's largest bets is against the US Dollar, specifically against the Euro. Taylor's rationale for this bet is nuanced, and is more fundamental than technical, which is surprising given his fund's primary trading strategy. Bloomberg News reports:

The prediction is partly based on his charts of the U.S. real estate cycle, which he says has a major impact on the dollar and will continue to point south for the next couple of years, dragging down the currency with it. He also says the price of a barrel of crude oil might reach $250 in 2011, further eroding the strength of the U.S. economy and the dollar.

Read More: Taylor Rules Currencies, Not to Be Confused With the Other Guy

I won't lie; the Forex Blog is admittedly Dollar-centric, in that developments in forex markets are usually assessed relative to their projected impact on the US Dollar. Sometimes, we forget that their are other currency pairs that move irrespective of the Dollar. Take the Australian Dollar and New Zealand Kiwi, for example. As both currencies are backed by high interest rates, they have benefited equally from the carry trade and as a result, they behave quite similarly. Combined with the fact that they are practically neighbors, it's easy to forget that there are unique circumstances that weigh separately on them.

Over the next 12 months, both countries' Central Banks are expected to significantly lower their benchmark interest rates as a result of slowing economic growth. However, as New Zealand does not have a large stock of natural resources to depend on in times of economic turmoil, it is projected to lower rates quite sharply, compared to Australia. Accordingly, the Australian Dollar may represent a buying opportunity against the Kiwi in the near-term. Bloomberg News reports:

New Zealand's dollar is likely to fall 8.7 percent to NZ$1.33 versus Australia's by year-end as the nation's economic slowdown accelerates, boosting prospects the RBNZ will lower borrowing costs...according to RBC Capital Markets.

Read More: Buy Australian Dollar Calls Versus New Zealand Dollar, RBC Says

When the credit crisis kicked off in 2007, several analysts quietly began to circulate the theory of "decoupling," which asserted the global economy was strong enough to weather a downturn in the US economy. In other words, it was expected that the credit crisis would be contained within the US, and the rest of the world would plod along, unaffected. This notion now appears to be completely without merit, except in a few isolated cases.

Instead, economies from Europe to Asia are sinking, and sinking fast. Some economies, namely Japan and Germany, have even begun to contract! Canada and Australia may slide into recession, regardless of what happens in commodity markets. Within this context, the Dollar's 10% rally is not much of a mystery. In other words, this rally is probably more a function of economic weakness in other countries than of US economic strength. In addition, the end of de-coupling works both ways; a global economic downturn could further harm the US. A wave of negative economic data and/or the next round of debt write-downs could send the Dollar spiraling downwards. The Telegraph reports:

We are not witnessing a dollar rally so much as a collapse in European and commodity currencies. The race to the bottom has begun in earnest.

Read More: Dollar surge will not stop America feeling the effects of a global crunch

When the credit crisis kicked off in 2007, several analysts quietly began to circulate the theory of "decoupling," which asserted the global economy was strong enough to weather a downturn in the US economy. In other words, it was expected that the credit crisis would be contained within the US, and the rest of the world would plod along, unaffected. This notion now appears to be completely without merit, except in a few isolated cases.

Instead, economies from Europe to Asia are sinking, and sinking fast. Some economies, namely Japan and Germany, have even begun to contract! Canada and Australia may slide into recession, regardless of what happens in commodity markets. Within this context, the Dollar's 10% rally is not much of a mystery. In other words, this rally is probably more a function of economic weakness in other countries than of US economic strength. In addition, the end of de-coupling works both ways; a global economic downturn could further harm the US. A wave of negative economic data and/or the next round of debt write-downs could send the Dollar spiraling downwards. The Telegraph reports:

We are not witnessing a dollar rally so much as a collapse in European and commodity currencies. The race to the bottom has begun in earnest.

Read More: Dollar surge will not stop America feeling the effects of a global crunch

Over the last few years, the inverse relationship between the price of oil and the value of the US Dollar has been remarkable. As the Dollar has fallen to record lows, oil has risen to record highs. Now, with a massive Dollar rally underway, the price of oil has virtually collapsed. This relationship is understandable, since expensive oil contributes to the US trade deficit and crimps the economy, while the weaker Dollar, in turn, drives oil-producing countries to charge more in Dollar terms for their oil so that the price remains constant in absolute terms.

However, there are signs that this link may be coming to an end. Hedge funds, which are famous for spotting such trends and riding them to profitability, are winding down their long/short positions in currency and commodity prices because such strategies have evidently become unprofitable. Apparently, analysts and traders expect other fundamental factors to assume control over the price of oil and the Dollar. Namely, the still-unfolding credit crisis and the projected long-term supply/demand imbalance in energy markets will become more relevant. In short, don't expect a further drop in the price of oil to necessarily help the Dollar, and vice versa.

Read More: Dollar-Oil Relationship In Doubt As Market Drivers Diverge

The Euro has dropped almost 10% against the Dollar in a matter of mere weeks and everyone is wondering why. Setting aside the factors which favor the Dollar generally (irrespective of the Euro) because they were explored in previous posts, let's instead examine those factors weighing specifically in the Euro. First, the recent decline in commodity prices is causing European inflation to abate. The Euro had previously derived significant support from the ECB's hawkish stance towards fighting inflation. With lower prices, however, the need for further rate hikes may have evaporated. Second, the Euro-zone economy is looking increasingly fragile. Based on the most recent data, it actually contracted in the second quarter. Truth be told, the ECB hasn't yet turned its attention from inflation to the economy, but if both prices and economic growth continue to slow, the Central Bank may be forced to loosen its monetary policy. In fact, the perceived inevitability of this fate may already be propelling traders to dump the Euro. Money and Markets reports:

While upping his concern for the euro economy, European Central Bank President Trichet has maintained his focus on rising prices. The latest predictions...however, point towards inflation having already peaked...

Read More: Dollar's Rise Helps Level the Currency Playing Field