U.S. DOLLAR INDEX NEARS THREE-YEAR HIGH AND HAS BECOME WORLD'S STRONGEST CURRENCY -- EURO AND SWISS FRANC WEAKEN ON BAD ECONOMIC NEWS -- FALLING METAL PRICES WEIGH ON AUSTRALIAN DOLLAR -- SURGE IN DOLLAR/YEN REMAINS MAIN DEPRESSANT ON GOLD
DOLLAR INDEX NEARS THREE-YEAR HIGH ... Chart 1 shows the U.S. Dollar Index challenging its mid-2012 high near 84. An upside breakout through that prior peak (which appears likely) would put the dollar at the highest level since mid-2010. The dollar has become the world's strongest currency. One of the reasons for the stronger greenback is the fact that the U.S. economy is now the strongest among developed markets. Another is chatter that the Fed is planning to cut back on bond purchases (quantitative easing) sooner rather than later. That's in contrast to other central bankers who are accelerating their easing process. Japan is the biggest example of that. But the weaker yen has forced the South Koreans to lower rates to weaken their currency (the won). [A plunging yen has pushed money into the higher yielding won which hurts South Korean exports that compete with Japan]. Europe has lowered rates to combat the longest recession in the postwar era. Australia has lowered rates to combat the deflationary impact of falling commodity prices and slowing Chinese demand. [80% of Australia's exports to China are natural resources]. The stronger greenback has a lot of intermarket implicatons for other markets, which include commodities and stocks.
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Chart 1
EURO NEARS NECKLINE AS SWISS FRANC BREAKS SUPPORT... When studying the trend of the U.S. dollar, we always have to start with the Euro which accounts for more than half of the Dollar Index (57%). Chart 2 shows the Euro tracing out an apparent "head and shoulders" topping pattern since last autumn. [A H&S top is characterized by three peaks, with the middle peak (the head) surrounded by two lower peaks (the shoulders)]. Chart 2 also shows the Euro nearing a test of its "neckline" drawn under its 2012/2013 lows. A decisive drop below that neckline (which appears likely) would be a bearish development for the Euro. Chart 4 shows the Swiss Franc having already tumbled to the lowest level since last summer. Although not shown here, the British pound and Swedish Krona have also been dropping. Economic news out of Europe remains weak which raises the odds for more ECB easing in the form of lower rates.
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Chart 2
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Chart 3
FALLING COPPER PRICE WEIGHS ON AUSSIE DOLLAR... I've written before about how falling commodity prices were hurting countries that export commodities like Brazil and Canada. [I've also shown that a weak Chinese stock market, which implies a weaker Chinese economy, was weighing on the price of commodities and countries that export them]. Australia is now feeling the negative effect from weak Chinese demand and falling commodity prices. Chart 5 shows the Aussie Dollar having fallen to the lowest level in a year and threatening to break a rising trendline drawn under its 2011/2012 lows. The Aussies recently lowered interest rates to combat a slowing in commodity exports (especially mining). Lower rates have hurt the Aussie Dollar. The brown area shows that the falling price of copper may also be weighing on the Aussie Dollar. [A Tuesday Wall Street Journal article suggested that a hot trade now is selling the Aussie and buying the Mexican Peso. That's a bet on the the strength of the U.S. economy versus China. Most of Mexico's exports to the U.S are manufactured goods, which also makes them less sensitive to falling commodity prices].
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Chart 4
PLUNGING YEN HAS REALLY HURT GOLD... My Market Message from last December (20) carried the headline: "A Peak in the Yen Appears to be Dragging the Price of Gold Lower". The weekly bars in Chart 5 show the price of gold peaking during the fourth quarter of last year and tumbling to the lowest level in two years during 2013. The green line shows the U.S. Dollar rising against the yen during that same time span. The upturn in the dollar/yen (green circle) during October coincided exactly with the peak in gold. Since the start of October, the dollar has risen 24% against the yen, while gold has lost -21%. By contrast, the Dollar Index has risen only 5% during those eight months, while the Euro has been flat. That appears to confirm my December view that the plunging yen has been the main driver of falling gold prices, and not the USD which is dominated by the Euro.
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Chart 5
SIDE-EFFECT OF A STRONGER DOLLAR INCLUDES STOCKS DOING BETTER THAN COMMODITIES... This headline is taken from a Market Message I wrote on March 14 which discussed intermarket implications of a rising dollar. Since commodity prices are negatively correlated to the dollar, it makes sense that they would be hurt by a rising greenback. By contrast, a rising U.S. currency has been reflective of the view that the U.S. economy is the strongest in the world which bodes well for U.S. stocks. Chart 6 shows the S&P 500 (black bars) rising since the spring of 2011, while the CRB Index of nineteen commodity prices has been dropping. In my view, the main reason for that divergence between stocks and commodities has been the rising U.S. dollar. The green line plotted along the bottom of Chart 6 shows three bottoms in the Dollar Index during spring 2011, last September, and this February (green arrows). The vertical lines marking those three dollar bottoms line up perfectly which three corresponing peaks in the commodity index (down arrows). I expect stocks to continue to outperform commodities for as long as the U.S. dollar keeps rising.
