CTS Spotlight for the week of January 28, 2011

Hello and welcome back to CRI's CTS Spotlight,

01/28/11: In a week that saw a stunned western world watch the middle east implode once again the markets are hinting at a possible end to our two year cyclical bull run. From bond markets threatening to bottom, to faltering stocks, to a break in energy, to a top in gold - there are mounting signs of consolidation rather than growth. While one event rarely stops a bull in its tracks and no new sell signals have been generated; one must appreciate where we have come in a very short period of time. This week's CTS spotlight will look at the Australian dollar and how it has performed as an excellent proxy for the past couple years of growth and how it may be effected by natural market forces going forward.

Australian dollar

Several interesting things jump out at me when I look at the currency 'down-under'. First off, it certainly has been a bumpy ride over the past few years (monthly chart below). Of course, regular readers of CRI's publications will remember well the monster bottom in the AD in '09 and our associated TTA. That trade has proved to be enormously profitable and I personally would like to congratuale anyone who was fortuante enough to be able to take advantage of it. Really, the text book definition of a Rational Investment. Once the technical bottom was in (April '09) the fundamental story powered this market for an almost immediate .20 cent gain!


The primary driver (from the fundamental perspective) was the dramatic spread between US and Australian short term Governement guaranteed interest rates (at that time you could borrow in the US at .25% and buy Aus. at 3% or more). When it comes to you and me it doesn't mean much, but when it comes to major corporations (keep in mind many US corporations are sitting on mountains of cash) and or governments themselves, 2 or 3% 'free' money (they didn't have to do a thing to make the return!) can equate to some serious cash.


This may be starting to change. While the US Fed has continued to signal that there will be no change in US short term interest rate policy soon, the impetuous for high Australian rates may be beginning to wain. On top of the fact that China and India (the areas super economies and primary consumers of Australian commodities) are in the midst of trying to slow their respective economies due to rising inflationary pressures (have you seen the price of cotton lately!) Australia has been hit with a natural disaster of 'biblical proportions'.  Should there be continued signs of economic retraction from the area's primary consumers and/or Australia itself needs to go through a period of consolidation/clean-up, Central bankers may feel lower rather than higher short term interest rates are warrented. Should this potential trend change gain traction we will need to refer to the charts for position guidance. 


Technically speaking, the weekly chart (chart above) is forming a coil that is getting tighter and tighter. It has NOT broken down but this looks to me like a classic rising wedge trap. This happens when the market makes higher highs and higher lows but the price pattern gets tighter and tighter (which has been the case for the Australian dollar since the broader market breakout last Oct-Nov). Should price 'top' (which would now be registered with a move below the weekly pivot line at .98) there are three significant price targets that weigh on this market going forward. Firstly, a 50% retracement of the rally since last June would bring prices back into the .9155 area. Second, there are two gaps that really ought to be filled at or near .92. Lastly, a correction back to the monthly trend line from the '08 peak to the late '09/early '10 peak would bring prices back into the .90 area. Put these three factors together and I think there is plenty of technical justification for this market to correct over the coming weeks/months.


The last consideration for a trader like myself (who hates the open ended risk of futures trading) is to shop the options market. Our time tested rule here suggests that we can make great money if we only consider buying an option if it has at least four months of time (really I like it to be at least 6 months) and its current price (or premium) is half what we expect the intrinsic value of the option will be when the underlying market hits our target. Since our target (I really like to use the weekly 50% rule here) is .9155, and the June .92 puts are currently about $.0060, there ins't any profit in doing the trade [our profit at our target would be: (.9200 - .9155) - 0.0061 (premium) = -.0016 (loss!)]. In essence, we would guess the market direction right and yet still lose money! This is the danger of the options market and drives home the point that just because you can guess market direction doesn't mean you can make money! Should this option get into the $.0020 area and the market has yet to break in earnest, we might get interested in the trade - but not now.


Having said all that, it is good to review and prepare.....you don't always have to trade


That's all for this issue of the CTS Spotlight,
Brian Beamish FCSI
the_rational_investor@yahoo.com
http://www.the-rational-investor.com