If all you’re watching is gold prices or the U.S. Dollar Index (USDX), you might be fooled into thinking the U.S. dollar is on firm footing again. After all, gold has leveled off lately and euro-zone debt problems in Greece, Ireland, Portugal and Spain mean that the dollar is looking good by comparison. Right?

Don’t be so sure. Plotting the strength of the dollar — or right now, its weakness — is much more complicated than watching the Dollar Index or seeing if gold is going up are down.

If the dollar is strong, so is the Mexican peso

In the first few days of April, some key commodities (notably energy and the metals) are up over 5%: Oil rose from $80 to nearly $87 a barrel in just one week – reaching an 18-month high. Natural gas gained 10.5% in just two trading sessions. Silver added over $1 an ounce (+6.3%), rising from $16.88 to $17.94. Copper hit a 21-month high over $3.60 a pound, rising 5.3% for the week. Platinum and palladium reached 17-month and 20-month highs of $1,679 and $493, respectively, up 4.7% and 7.9% for the week.

While most eyes were glued on gold (which rose only 1.9% last week) or the euro’s erosion to the dollar, the bigger story is that the dollar is steadily declining in terms of many other currencies. Meanwhile, gold has been a laggard among the precious metals. Year-to-date, platinum is up 14.3% vs. only 3.4% for gold.

In the currency world, the dollar has gained 6.2% to the euro (year-to-date), but it has lost the same 6.2% to the Mexican peso! The Canadian dollar is up 4.6% year-to-date and is now equal to the U.S. dollar. Currencies from the other resource-rich nations (like Australia, South Africa and Russia) are also beating the U.S. dollar. Last week alone, the U.S. dollar lost 2% to the Australian dollar, which is now up 47.5% in the last year. The Indian rupee is near a 19-month high and the Russian ruble just set a 15-month high.

Another commodity bubble?

If this tune sounds familiar, that’s because the same thing happened two years ago, before the financial crisis struck. All the talk then was about a “commodity bubble.” Oil was near $150 per barrel, gasoline cost $4 a gallon, copper hit $4 a pound, silver reached $21 an ounce and corn soared to $6.30 per bushel in the wake of the ethanol craze. Grain prices hit record highs during the June 2008 Midwestern floods.

The 2008 pundits warned of a classic bubble in commodities, but all they saw were the dollar prices. Most commodity prices were not rising so sharply in euro terms, or in Swiss francs or Canadian dollars. If you live and invest within the United States, you go about your daily life (and your investing) oblivious to how the rest of the world values commodities. But, in 20/20 hindsight, the early months of 2008 do not represent a commodity bubble as much as a U.S. dollar collapse, pushing commodity prices sharply up.

In the last year, we’ve seen a repeat of 2008, with rapid U.S. dollar-price increases in many commodities:

52-Week Commodity Price Changes n U.S. Dollars include a 70% leap in crude oil prices, a 120% surge in palladium prices, and an 83% surge in copper prices. (Sorry goldbugs, the yellow stuff is “only” up 30%)

The Dollar Index (USDX) masks real dollar trends

If you only watch the “dollar index,” there is no way you can know how sick the dollar really is.

The U.S. dollar index (USDX) compares the greenback to a basket of six major currencies, using 1973 as an index standard (100). By that measure, the dollar bottomed out on March 17, 2008 at 71.18. Not by co-incidence, that was the first day gold surged over $1,000, reaching $1,032 per ounce. Four months later, on July 14, 2008, the USDX tested its March lows, dipping to 71.91 before rising sharply into early 2009. In the first week of March 2009, the USDX dollar index peaked at 89.20, for a net 25.3% gain.

However, the Dollar Index is misleading, since that index is overly-dominated by the euro (with 57.6% weighting). Five other currencies share the remaining 42.4%: The Japanese yen (13.6%), British pound (11.9%), Canadian dollar (9.1%), Swedish krona (4.2%) and Swiss franc (3.6%). This archaic formula has only been changed once since 1973 — at the launching of the Euro on January 1, 1999.

With all due respect to the Swedes and the Swiss, those two nations are not among the top six economic engines of the world. Why not minimize the euro-dominance of the index and acknowledge the rise of the BRIC countries (Brazil, Russia, India and China) by updating the Dollar Index? As is, the dollar’s rise to the euro, based in large part on the financial crisis in Greece and other euro-zone nations, has bloated the Dollar Index out of all proportion to the dollar’s fading fortunes elsewhere around the globe.

Why the weak U.S. dollar will only get weaker

 The dollar is now being weighed down by record-high budget deficits and easy money at the Fed. Printing trillions of new dollars, either as cash or credit, has serious implications for the future of the dollar. Meanwhile, the budget deficits in both 2009 and 2010 (combined) will top $3 trillion. The federal government is spending more borrowed money than taxed money these days, a formula for devaluation.

From foreign eyes, the dollar offers no return on short-term deposits, with the very real danger of deep capital losses. Now that the 10-year Treasury bond is approaching 4%, some foreign investors might be lured back into the U.S. dollar or bond market, but who wants to lose 10% in principal for every 4% slice of annual income? The dollar offers little attraction to those seeking total returns in a global marketplace.

Currency markets are open 24-hours-a-day and trade nearly $3 trillion daily. The currency markets are stronger than any central bank or a cabal of minor central banks. The currency market disciplines global governments for their profligate policies – and it does so long before the crisis becomes evident at home.

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