CURRENCY TRENDS SHOW THAT MARKETS ARE STILL RISK AVERSE -- A BOUNCING DOLLAR HURTS COMMODITIES AND A RISING YEN IS BAD FOR STOCKS

RISING DOLLAR PRESSURES GOLD AND STOCKS... Last Friday, I wrote about how a rising dollar was putting downward pressure on most commodity markets and gold in particular. I showed gold backing off from its 200-day moving average while the US Dollar Index was bouncing off its 200-day line. That inverse trend between the two markets is evident again today. The U.S. Dollar Index is bouncing and gold is falling. The two lines in Chart 1 show the strong inverse relationship between gold and the dollar. My main focus today is on the dollar and the yen. That's because the direction of those two currencies tells us a lot about the trend in other markets, mainly stocks and commodities. Bear in mind first of all that commodities and stocks have been falling together since midyear for the same reason, which is a global recession. That being the case, stocks and commodities are now linked together. It's unlikely that most commodities will experience a major upturn until after the stock market does. And there's no compelling evidence of that happening anytime soon. Since a rising dollar hurts commodities, and stocks and commodities are linked, that becomes potentially negative for stocks as well. Another sign that investors remain risk averse is the continuing rise in the Japanese yen.

Chart 1

YEN RISES AS EURO FALLS ... Perhaps the best way to explain the implications of foreign currency moves is to compare the rising yen to the falling Euro which is done in Chart 2. That chart shows the yen denominated in Euro (orange line) rising since midyear when the Euro (blue line) started to tumble. There are two dynamics at work here. It was the tumble in the Euro at midyear that signaled that economic weakness had spread abroad and would force foreign central banks to lower rates more aggressively. That turned the dollar (not shown here) higher. In other words, dollar strength since midyear has been based more on foreign weakness than on U.S. strength. The dollar became a safe haven from tumbling foreign currency markets. Hence, a rising dollar (falling Euro) is a sign of fear. That also accounts for the strength in the yen. The yen bottomed against the dollar in mid-2007 as the "yen carry trade" started to unwind which forced global traders to cover their yen shorts and sell assets elsewhere on the globe. Chart 3 shows the yen against the dollar (orange line) and against the Euro (blue line) over a four-year period. The yen turned up against the dollar in mid-2007 as global stock markets started to peak. The surge in the yen/Euro (blue line) started at mid-2008 and accompanied the second global downleg. That's when commodity prices started to tumble and things got a whole lot worse.

Chart 2

Chart 3

WHY A RISING DOLLAR AND YEN ARE NEGATIVE FOR STOCKS AND COMMODITIES... Chart 4 plots the Euro (blue bars) against the CRB Index (solid line). It's clear that a falling Euro since mid-year has hurt commodities and will continue to do so. Chart 5 compares the yen/$ to the Dow Jones World Stock Index. The chart shows that the upturn in the yen in mid-2007 coincided closely with the global stock market peak. The two markets have trended in opposite directions since. That's why the fact that the yen is rising again (against the dollar and the Euro) is potentially negative for stocks. And why a falling Euro against the dollar is potentially bad for commodities.

Chart 4

Chart 5