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Market Debate: Long Commodity/Short Dollar Unwinding Or Not?

So what's next? The job market is weak, but not falling apart. More importantly,the dollar rally is continuing, and here is where the debate is centered. Does the long commodity/short dollar trade continue to unwind?

The Street is split:

--Those who say "Yes!" insist that today's commodity bounce is a blip, that traders looking for dollar assets, and that the weaker dollar will shake out international speculators. This last point is a good one: allocations into commodities as an asset class has increased dramatically since the dollar decline accelerated in September 2007, so the correlation between commodities and the dollar has increased. Many of the international players who moved into commodities did it largely in response to the weaker dollar; without that weaker dollar, that reason for ownership is less strong.

--There is also an equally vocal group who say "No!," the main argument of this camp is that the gradually strengthening economy will keep commodities strong, even conceding a stronger dollar. To the extent that the rise in commodities is a function purely of supply/demand imbalances, they are right. But the rise of commodities, particularly since September, is not due purely to supply/demand issues, as I note above. It is heavily influenced by international investors trying to protect themselves against the weak dollar. So are commodities 10 percent over-inflated due to those seeking protection against the dollar, 20 percent? We don't know yet, but it is some multiple.

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