Hello and welcome back to CRI's CTS Spotlight,
07/08/11: The US Dollar index continues to consolidate its recent bottoming action amid the turmoil of the European debt situation. Since this is the first two weeks of Q3'11, we shall watch for trends developing to give us an idea of where markets may want to go over the entire quarter. Of particular note this week, copper, lumber and the Nasdaq have confirmed bullish trends while the grains and energies looks weak.
During this horrible time in CRI's personal life, CTS Spotlight has suffered. Indeed, it has been a couple months since we last updated CTS Spotlight so to refresh things I thought we ought to take a good look at the US Dollar index to see if it is trying to tell us anything.
The US dollar index is one of only a few markets that is negatively correlated with the broader market. My take on it (as of 2000) is that US dollar weakness is considered a market positive in that when the index is dropping it means that international money is looking for growth. It also means that US exports become cheaper (and more competitive) in the international market which helps US company profits. Conversely, when the US dollar index is rising, it means international money is fearful and running into the only 'safe haven' out there which in turn hurts US company profits. To confirm this notion we need only look at the two world commodity currencies to see that indeed, as the world inflates (commodity prices rise) both the worlds commodity currencies appreciate and when the world deflates (commodity prices fall) both the world's commodity currencies depreciate.This is the hallmark of the 17.5 'fear-cycle' we entered at the turn of the century and ought to persist for at least another 6 years.
As the chart above clearly demonstrates, the US dollar index has been in a steady decline for the past year. As the world has reflated from the 2008 recession, international money has poured out of the US and into various international markets to take advantage of the growth. In essence it is a carry trade where money is borrowed in the US (at historically low interest rates) and invested in 'high growth' areas of the world. That has been primarily the emerging economies or what are known at the BRIC countries (Brazil, Russia, India & China). One will also recall how the US stock market as measured by the S&P 500 index (and really the whole world) has enjoyed a substantial bull run since last fall. That all may be changing. (Regular readers of CRI's SPY blog will be well aware of both the seasonal top that has been anticipated, but also the cycle top that is projected for late Q3'11.)
While the fundamentals are still a little unclear at the moment, two drivers seem to be emerging.
1. QE2 has come to an end in the US. This very controversial program (where the US Fed has literally pumped billions of dollars into the market) has met its economic/political objectives and further directed US dollar depreciation efforts by central bankers will not occur again unless we see another 'melt-down' in asset prices. As well, GOP political rhetoric has all but killed further US Federal government (fiscal) spending going forward.
2. The credit-crunch in Europe is back on. One by one, the marginal countries of the Euro-zone (Greece, Portugal, Ireland, Spain and now Italy) are coming under pressure to either raise taxes or cut government spending. Since many of these countries have horrible tax collection records - the only realistic alternative for them is to cut spending. This is never popular with the public and will meet a lot of resistance. Indeed, if taken too far these types of measures can lead to revolution - lets hope it doesn't come to that. The point of all this is that 'growth' is definitely on the back burner. Countries in the Euro-zone are shrinking not growing and this all plays back into the US dollar index.
So with all this being said, it shouldn't surprise us to see a technical bottom in the US dollar index of late. Since April, the greenback has been slowly appreciating and while not a stunning bull market, one has to respect the fact that the index is NOT trending lower. In fact, as of two weeks ago, it has confirmed a double bottom price pattern suggesting that the index actually wants to go up not down going forward. This represents a fundamental shift in the market and is very important.
For an idea of where the index may want to go in the coming weeks/months we refer to the 50% rule. Since it's peak last year, the index has fallen from the high 80's to the low 70's. A 50% retracement of this move would bring the index back into the 81-82 area and that has to be at least our preliminary target going forward.
As an added feature of this commentary on the US dollar index, I thought we would include a very interesting chart done by the good people at FSC (website). These guys are cycle gurus and their recent work on the gold market is startling to say the least.
According to their work (red line) gold prices could see a precipitous decline in the near future. This is important because it confirms our notion that the US dollar index wants to rise - or that the 'fear' vote in the market is overwhelming the 'greed' vote. Historically, the US dollar and gold move in opposite directions (where gold is the ultimate inflationary proxy and the US dollar index is the ultimate deflationary proxy). Should their cycle analysis prove correct, we ought to see a dramatic fall in gold prices over the coming weeks/months as the world 'deflates'.
So in summary then, the technical double bottom in the US dollar index must be appreciated. The end of QE2 means that the 'easy' monetary policy days in North America are over for now. Additionally, the Euro-zone debt issues have, for the time being, brought growth from Europe into question. These deflationary fundamentals mean there isn't a guaranteed floor in the market and prices are vulnerable. Add these fundamental drivers with some simple cycle analysis (FSC chart above) and we have the makings for a dangerous market going forward.
Brian Beamish FCSI
the_rational_investor@yahoo.com
http://www.the-rational-investor.com
