11.18.08: Given rate cuts in Europe for the British Pound and the Euro, aren't we likely to see further strength in the dollar, which will drag down our energy and agricultural stocks?

Maybe—but the reality is that nothing is simple in the market right now.

You are bringing up a fascinating subject. The strongest currencies in the world since mid-July are the Japanese Yen and the U.S. dollar, but ironically they also have the lowest interest rates. You might wonder why countries with the lowest interest rates perform the best. Shouldn't it be the opposite? Well, let me try to explain what may really be happening.

The worst performing hedge funds this year, so-called Convertible Arbitrage hedge funds, are now down over 50% on average this year. These institutions specialize in something called the "carry trade." That is where a hedge fund borrows in Japan or the U.S. at a low interest rate and then invests in a country with a higher interest rate, such as Brazil or New Zealand. This arbitrage works great until the Japanese yen or U.S. dollar rallies, then this type of investment can end up costing you dearly.

The bottom line is no one really knows just how leveraged these Convertible Arbitrage hedge funds are that are being hit with redemptions and are being forces to sell corporate bonds and foreign debt at fire sale prices. So it appears that much of the U.S. dollar's strength is tied to the carry trades coming unwound, which could be in the trillions, due to the leverage that Convertible Arbitrage hedge funds utilize. This type of sketchy hedge fund activity was a big focus of the G20 meeting recently.

Since approximately 88% of the world's commodities are priced in U.S. dollars, as the U.S. gets stronger, commodity prices naturally decline. The U.S. dollar has rallied from $1.60 relative to the euro to only $1.24 recently. It is hard for me to imagine the U.S. dollar rallying much more, since I assume that most carry trades have been likely unwound in the past few months. As a result, I believe that many agricultural and energy stocks are oversold and are poised to rebound.

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