Using Diamonds To Track The Dow

By Gregory S. Davis | March 08, 2009 AAA

Fear in the markets compels investors to move funds into investment vehicles offering the promise of security. One such example of an asset benefiting from a flight-to-quality is the strength the U.S. dollar, which is showing amidst the mounting negative news concerning the U.S.recession and the global economic slowdown. Let's take a look at how a devaluation of the U.S. dollar could send a signal of a rise of U.S. stock markets and how investors can use ETFs to follow the action.

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Not Just the Dow
Just focusing on the Dow Jones Industrial Average (DJIA) is a perilous and disheartening method to use if investors are hoping to figure out when it will hit bottom. Tracking the DJIA can be accomplished by following the DIAMONDS Trust, Series 1 (NYSE:DIA) which is designed to match the performance of the DJIA. The DIA fund was one of the top 20 most actively traded ETFs on March 6, 2009 as the Dow managed to close up above 6,600. The DIA fund has accurately followed the Dow downward returning negative 24% since the beginning of the year through March 6 and negative 39% over the previous three years.

Rising U.S. Dollar
With the Dow trading below the 7,000 mark since the beginning of March investors should also take note of the upward momentum of the U.S. Dollar Index (USDX) which has pushed above 88 from lows near 70 one year ago. Using the PowerShares DB US Dollar Index Bullish (NYSE:UUP) as a proxy for the strength of the U.S. dollar we can see that the fund has risen over 7% since the beginning of the year through March 6, while returning just over 6% to investors over the prior two years.

Knowing when We've Hit Bottom
Given the inverse relationship displayed between the DIA and the UUP funds, an argument could be made for a weakening U.S. dollar equating to an eventual rise of the Dow.

This argument suggests that investors should also keep an eye on the PowerShares DB US Dollar Index Bearish (NYSE:UDN) for signs of strength, since it is designed to benefit from a weakening U.S. dollar through the use of short futures contracts. The UDN fund is down -7% since the beginning of the year through March 6. (To learn more about the relationship between the stock and currency markets, read Currency Moves Highlight Equity Opportunities.)

Final Thoughts
Predicting the bottom for the Dow is nearly an impossible task and should not be the focus for individual investors. Rather, investors with the stomach for uncertainty, the willingness to plan and time for their investments to appreciate long-term should consider a dollar-cost-averaging approach for acquiring assets with current negative returns as a play on a reversal of fortune for the depressed investments in the years to come.

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