FALLING EURO BOOSTS THE DOLLAR -- ECB THURSDAY ANNOUNCEMENT SHOULD DETERMINE EURO DIRECTION AS IT TESTS 200 DAY AVERAGE -- FALLING TREASURY BOND YIELDS ARE PART OF GLOBAL RETREAT -- BOUNCING DOLLAR CAUSES PROFIT-TAKING IN COMMODITIES
DOLLAR BOUNCE IS TIED MAINLY TO EURO DROP... When studying the trend of the U.S. Dollar Index, it's a good idea to study the trend of the Euro as well. That's because the Euro has the biggest influence on dollar direction (57%). [The Japanese yen has a much smaller weight of 13%]. That makes the Euro almost a mirror image of the USD. A visual comparison of the Dollar Index (green bars) with the Euro (blue line) show their strong inverse relationship. That visual impression is confirmed by the 20-day Correlation Coefficient (below chart) with a negative correlation of -0.99. Correlations can't get much stronger than that. [The 60-day correlation is also very high at -0.87]. Over most of the last year, a rising Euro has coincided with a falling dollar. Since the start of May, however, the dollar index has risen 1.1% while the Euro lost -1.6%. [The dollar bounce has been held back by gains in the yen and Canadian dollar]. Forex traders trying to decide what to do with the dollar and Euro might want to watch developments in Europe very closely this week.
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Chart 1
CHARTING THE EURO ... The weekly bars in Chart 2 show the Euro backing off from a major resistance line drawn over its 2008/2011 highs. One of the reasons for recent Euro weakness is the ECB threat (more like a promise) to take steps this week to combat the threat of deflation. The lowering of short-term rates is the least that's expected to be announced. The ECB would also like to see a weaker Euro for two reasons. One is because a stronger currency is deflationary. A second reason is that a weaker Euro would boost European exports. It remains to be seen what the ECB does on Thursday, and how the Euro reacts to it. Meanwhile, all we can do is watch the charts for guidance. The daily bars in Chart 3 show the Euro having fallen to the lowest level in three months. It's now in the process of testing its (red) 200-day moving average. What happens from there will help determine whether recent Euro weakness is temporary, or something more lasting. And what the Euro does will have a huge influence on the direction of the dollar.
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Chart 2
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Chart 3
FALLING TREASURY YIELD MAY HAVE MORE TO DO WITH FOREIGN TRENDS... Analysts have been trying to figure out why Treasury yields keep falling, especially this week's drop to the lowest level in nearly a year. Normally, falling Treasury yields imply a weaker U.S. economy combined with low inflation levels. It's quite possible, however, that the drop in Treasury yields might have more to do with foreign trends than those in the U.S. While it's true that the Fed has begun tapering its bond purchases, the Europeans may be about to start an easing process (which might eventually include bond buying). [The Japanese are still in the midst of an aggressive quantitative easing program as well]. In other words, the drop in sovereign bond yields is global in scope -- and the biggest drivers in that drop are foreign markets. U.S. bond yields are still among the highest in the developed world. Yields in most developed markets are at or near record lows. Germany's 10 year bund yield has fallen to 1.36%, compared with 2.45% in the U.S. [Bond yields in Europe's peripheral markets, which surged during the last Euro crisis, are now at all-time lows]. The fact that Treasury yields are higher than in many other countries actually adds to the appeal of U.S. bonds. Any action that the ECB takes to combat deflation should serve to push Euro bond yields even lower which would, in turn, have a depressing impact on Treasury yields. Lower bond yields around the world are forcing investors into higher-yielding and riskier assets like stocks. Easing moves in Europe should boost European stocks. Falling global rates also favor higher-yielding emerging markets.
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Chart 4
BOUNCING DOLLAR CAUSES COMMODITY PROFIT-TAKING... The dollar and commodity prices usually trend in opposite directions. It's no surprise then to see the recent bounce in the greenback causing profit-taking in commodity pits. Chart 5 shows the DB Commodity Tracking Fund (DBC) rising during the first four months of 2014, as the dollar weakened. During May, however, a rising dollar has caused commodity prices to drop. Agricultural markets have been among May's biggest lowers. Precious metals have also been hit hard.
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Chart 5
GOLD AND SILVER REMAIN IN DOWNTRENDS... Greg Schnell showed gold and silver prices falling back to support levels this week. Charts 6 and 7 put those negative trends in more perspective. The weekly bars in Chart 6 show the spot silver price falling back toward its lows of the last year. Silver's chart pattern over the last year resembles a "descending triangle" which is a bearish pattern. Silver remains in a major downtrend that started three years ago. The trend of spot gold in Chart 7 isn't much better. Gold also appears to be triangulating between two trendlines. Triangles in a downtrend are usually bearish. There are also intermarket forces working against gold.
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Chart 6
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Chart 7
GOLD HURT BY BOUNCING DOLLAR AND RISING STOCKS... One of the intermarket influences hurting gold is the bouncing dollar. Chart 8 shows the peak in gold in mid-2011 coinciding with a major upturn in the Dollar Index. Another USD bounce in autumn 2012 pushed gold lower. A weaker dollar over the last year helped support a rebound in gold. The recent ability of the dollar, however, to bounce off an important support line has caused gold to weaken. [Gold has a tendency to trend in the same direction of the Euro. That's another reason for gold traders to watch the ECB announcement this week, and how the Euro reacts to it]. Rising stock prices also hurt gold. Gold did especially well between 2000 and 2010 during the "lost decade" in stocks. Chart 9, however, shows falling gold prices since 2011 coinciding with rising stock prices. Gold prices fell especially hard in spring 2013 after the S&P 500 hit a record high (see circle). One factor that usually works in gold's favor is falling bond yields. Since gold is a non-yielding asset, it does better when yields are low. It appears, however, that rising stocks prices are having more of a negative effect on gold than the beneficial effect of falling yields (rising bond prices). There may be a reason for that.
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Chart 8
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Chart 9
STOCKS ARE NOW STRONGER THAN BONDS... Bonds and stocks compete for investor funds. When investors are pessimistic, they favor bonds. When they're optimistic, they favor stocks. The best way to monitor which market is winning is with ratio analysis. And right now, that analysis favors stocks. Chart 10 plots a ratio of the S&P 500 divided by the price of the 30-Year Treasury bond. The stock/bond ratio fell sharply between 2000 and 2002, and again during 2007 and 2008. Bonds did much better than stocks during those bear markets. Stocks, however, did better between 2003 and 2006, and the five years since 2009. The stock/bond ratio took a more positive turn in spring 2013 when it exceeded its 2011 peak (and the S&P 500 hit a record high). By the second half of 2013, the ratio had broken a thirteen-year resistance line drawn over its 2000/2007 highs. The major trend of the stock/bond ratio now favors stocks. [The stock/bond ratio has been consolidating during the first half of 2014 as both markets have risen together. The major trend, however, still favors stocks]. Rising bond prices (falling yields) are generally good for gold. That's not necessarily true, however, when stocks are doing even better than bonds.
