CHINESE REVALUATION HAS EXPECTED RESULTS -- YEN SURGES -- BOND YIELDS START TO CLIMB -- GOLD IS BOUNCING

MARKETS FOLLOW REVALUATION SCRIPT... Over the last year I've written several articles on the possible implications of a revaluation of the yuan by the Chinese. [Type "yuan" in search box under archived market messages]. An April 22 piece was headlined: "Why a Higher Yuan Might Not Be That Good For the U.S." (April 22, 2005). The April article spelled out the possible intermarket effects that would take place when the yuan started to rise. I also covered these points in my book on Intermarket Analysis. To repeat some of the points made in those earlier writings, one side effect would be a weaker dollar. Most of the currency gains would be felt in Asia and Japan in particular. With the Chinese and Japanese buying fewer dollars to hold their currencies down, they would have fewer dollars to buy U.S. Treasuries. That could boost U.S. bond yields. A weaker dollar would benefit gold. It would also make foreign markets more attractive investments, especially in Asia. A May 23 article contained a paragraph headlined: "Will China Burst Housing Bubble?" (May 23, 2005). That was a reference to the fact that Asian buying of Treasuries was helping to keep U.S. bond yields low and the housing market strong. A yuan revaluation could set in motion a series of events that could start to push U.S. mortgage rates higher and housing prices lower. Some of today's inital reactions to the Chinese revaluation have followed the expected intermarket script pretty closely. One of them is a jump in bond yields. Chart 1 shows the 10-year T-note yield jumping to a two-month high and climbing back over its 200-day moving average. That's causing heavy selling in rate-sensitive stocks like utilities. It may have also caused profit-taking in the rest of the stock market.

Chart 1

YEN SURGES ALONG WITH ASIAN ETFS ... Another side effect of a higher yuan would be stronger Asian currencies and the Japanese yen in particular. It's no surprise then to see the yen surging today against most of the world's major currencies -- including the dollar. Chart 2 shows the yen bouncing off chart support formed in the spring of 2004. Its 14-day RSI shows the yen in an oversold condition. Other Asian currencies rose as well including those in Malaysia, Singapore, and South Korea. [Malaysia dropped its seven-year peg between the ringgit and the dollar]. Stronger currencies explain why Asian Exchange Traded Funds were strong today. The day's strongest foreign ETFs were Malaysia (EWM), Singapore (EWS), South Korea (EWY), and Australia (EWA). Chart 3 shows the Malaysia iShares (EWM) soaring today to a new 2005 closing high.

Chart 2

Chart 3

A WEAKER DOLLAR SHOULD BOOST GOLD ... With the Chinese announcing their intention to tie the yuan to a basket of currencies, it seems logical to assume that the value of the dollar could start to erode. There's now less of a reason for the Chinese (and the Japanese) to keep buying so many dollars to keep their currencies from rising. A weaker dollar should translate into a stronger gold market. Chart 4 shows the Gold ETF (GLD) climbing the equivalent of $2.50 today. It's also starting to bounce off chart support along its late-spring low. Gold stocks were the day's strongest stock market group. Chart 5 shows the Gold/Silver (XAU) Index moving back up toward its 200-day moving average. Both the GLD and the XAU have more upside work to do to turn their trends higher. But both did what they were expected to do today in the face of the Chinese news. If today's 2% revaluation is just the start of a trend toward a higher yuan, it's possible that today's initial reactions in the dollar, bond, and gold markets are just the start of bigger moves to come as well.

Chart 4

Chart 5