April 12, 2010 - The Big Picture in Currencies

We really need to do a complete overhaul on things since we've been out a while.  In fact, we've been out designing some software to assist in market analysis.  Unfortunately, the project has taken on a life of its own, and as a result, we've neglected some blogging duties...

We'll kick things off by looking at currencies.

Currency Vs. Commodity Markets
One significant change that has occurred since the end of January is that the correlation among markets has broken down.  With the debt problems in Europe coming to light since last November, there has been an increase in non-USD denominated purchases of commodities, notably gold.  Here's a chart that shows the correlation, and (fairly) recent breakdown, more closely.

The above chart shows the S&P 500 (red) vs. crude oil (represented by West Texas Intermediate Crude in black) vs. gold (gold) vs. the US dollar (green).  We've drawn some straight lines through the major trend points simply to emphasize the general trends.  The correlation really began to break down in December as the dollar rallied due to euro weakness and fears of debt contagions, yet the S&P continued to move up.  Crude oil soon broke its correlation and finally, gold broke its correlation in February.  The effect is emphasized when you do a similar comparison between commodity currencies, notably the Australian dollar and the Canadian dollar, vs. the US dollar.

The above chart comparing currencies is significant.  The US is in no position to raise rates.  Europe is likely generally thrilled about a weaker euro (improves exports).  In the last 10 years, the euro has been perceived as the "anti-dollar."  The perception now appears to be shifting such that the dollar is perceived to be the "anti-euro."  In the past, traders and investors flocked to US dollars in emergencies.  When there was no emergency, they flocked to the euro, and to a lesser extent the commodity currencies like the Canadian dollar and the Australian dollar (also, the Brazilian real and the Norwegian krona).  Now, as the euro is increasingly deemed to not be a suitable dollar replacement, investors are not only flocking to dollars, but increasingly to commodities (and by proxy, commodity-based currencies).  This should be taken as a sign of inflation at this stage as this will force rising prices and a flock to assets.

In fact, aside from the euro, most all currencies have held their own against US dollars even as it rallied.

The Australian dollar has been trading in consolidation rectangle since September 2009.  It broke out yesterday, and though we may get one more round of consolidation here, it appears to be setting a base to move much higher. 

We wouldn't be surprised to see the Aussie dollar act like the Canadian dollar below, which already broke out during the US dollar's "rally."

Note that there was a breakout and a successful retest of the rectangle before it took off again.  At this stage, it will probably consolidate a bit again before breaking and holding the key 1:1 psychological barrier.

The Brazilian real is in such a formation.  Note that it had a false breakdown in February and has actually set up an inverse head and shoulders pattern.  When it breaks above the rectangle, it should run with strength.

It's not just the commodity currencies.  Though it's not as well formed, it's clear that the Indian rupee has also done very well during a "strong dollar" period. (Note that there may be a consolidation period beginning now based on the last candlestick).

You probably get the point.  Commodities have held their own, even with a US dollar rise.  This rise has not been due to dollar strength, but due to euro weakness:

Even the lowly euro appears to be putting in a bottom.  In fact, this is not far from our projected bottom that we wrote about months ago:

There was a false breakdown, but it was very, very close...

Does this mean the euro is at THE bottom?  It's difficult to say for certain, but we're certainly due for a reasonable rally soon--probably to at least the 1.42 mark.  Note that it's up against the 50 day moving average, which will likely serve as short term resistance.  Expect to see a pullback to 1.34 before trying to break out again.

For the US dollar, this is significant.

The dollar appears poised for a move down.  Just as we'd remarked time and time again that the 50 dma served as resistance for the dollar during the entire March 2009 - December 2009 period, it has served as support since then.  However, it has now broken below that level for the first time since December.

Given the move down in the dollar and up in the euro in the last few days, we wouldn't be surprised to see the dollar rise again in the very short term (next few days) before really resuming its downtrend.

It typically takes several months (charts show 4-6 months) after a major currency move for that currency to really top.  So, we anticipate that we may have a minor pullback in the euro and strength in the dollar over the next few days.  Over the next few weeks we expect to see a resumption of the downtrend in the dollar.  Over the next few months, we'll be putting in a trading range in the euro and dollar, much like can be seen above in the Australian and Canadian dollars.  Expect some choppy trading between the major currencies between the current high/lows and their 150-200 day moving averages, but the emerging markets and commodity currencies appear ripe for upward moves, with Canada leading the way.  It's going to be interesting.

So, where does this leave the ultimate currency in this mess, gold?

Gold appears just about ready to make a run towards its all time high, set in December.  Note that in the very short term, that is in the next few days (much like the euro), it will probably do a little base building.  It has had quite a run in the last 11 trading days, with 9 of the 11 up days.  It's due for a correction.

Intermediate term, it's becoming difficult to gauge what's going to happen with gold.  Seasonally, it should be strong for the next month, with a long consolidation period beginning in late May or early June and running into October.  We're inclined to believe that we'll see gold run and challenge its highs, then pull back into this range during the summer before running again this fall.  However, given the global situation with debt, money printing, and increasing global tensions, it's entirely possible gold will ignore its traditional seasonal pattern and run higher.

For perspective, let's take a look at currencies in gold terms before we wrap it up.

The US dollar is clearly at an important support level in gold terms.  There are fundamentally two key support levels marked on the chart for the dollar in gold terms before a resumption of the dollar bear market can be called.  The first will likely fall in the next few days to a week.

The euro is in a marked bear trend relative to gold and may stay there.  The strong resistance is marked with the red line.  Euro weakness has led to gold strength as Europeans wake to reality that Europe is at least as bad off as the US.  This chart will bear watching closely over the next 4 months or so.

There's a tug-of-war brewing between the Australian dollar and gold.  There's currently a trading range.  Will the Aussie dollar break up and knock the gold price down?  Sorry, Australia, but like the rest of the Westernized world, your currency is sinking, too.  For context, take a look at the last 4 years:

Note the consistent pattern of consolidation (in rectangles) and breaking to the downside.  Breakouts are "V" shaped and only last a few months. 

Canada.  Same problem.

In fact, ALL currencies are falling relative to gold.  Their rate of fall and timeframe are different, but they're all falling over time.

The big picture is that we in a global race to the bottom with respect to currencies.  Be prepared.

Finally, one last little chart.  The gold/silver ratio.

We've shown this one before.  It's a 20 year view.  When the channel is rising, gold is outperforming.  When the channel is falling, silver is outperforming.  In the background you can see the individual gold and silver prices.  If both are rising and the channel outlined in blue is falling, then silver is gaining ground faster than gold.

The gold/silver ratio is at the top of the trend channel that began in March, 2009.  The trend since then has generally been down, though it has spiked outside of the channel.  This is not atypical behavior.  Note that these trend channels go on for years.  As it stands, silver may be the outperformer for a while...

Next time we'll take a look at equity markets, which remain in bullish trends but are overdue for some consolidation.

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