EUZOZONE CURRENCY AND STOCKS REMAIN UNDER PRESSURE -- GERMAN ISHARES SLIP BELOW 200-DAY LINE -- RECORD LOW BOND YIELDS IN EUROPE ARE PULLING TREASURY YIELDS LOWER -- UPTURN IN DOLLAR SHOULD LIMIT GAINS IN GOLD
EUROZONE REMAINS UNDER PRESSURE... The Eurozone has been under a lot of pressure lately as reflected in the falling Euro and stock prices. That downside pressure may increase with this week's announcement of more sanctions imposed on Russia. Eurozone countries are the most vulnerable to growing tensions in Ukraine. The green line in Chart 1 shows the Euro peaking in early May and falling to the lowest level in eight months. The blue bars show EMU iShares (EZU) in the process of testing their 200-day moving average. That's an important test. It may also be an important test for U.S. stocks which are already starting to show some stress. The fact that German shares are doing even worse is also concerning. Germany is the biggest economy in Europe and has been a stabilizing force in that region. Chart 2, however, shows Germany iShares (EWG) already trading below their 200-day line for the first time in two years. Foreign stock ETFs are falling faster than their cash markets. Since June 1, the EWG has fallen -4.8% versus a smaller drop of -2.9% for the DAX. Chart 3 shows German DAX Composite, which is off 0.72% today (red down arrow), still above its 200-day line (red up arrow). The difference in their performance is tied to the falling Euro. The DAX is quoted in a weaker Euro, while the EWG is quoted in a stronger dollar. An index quoted in stronger currency (EWG) will fall faster than one quoted in a weaker currency (the DAX).
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Chart 1
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Chart 2
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Chart 3
FALLING EURO YIELDS ARE PULLING TREASURY YIELD LOWER... Geopolitical tensions in Europe, signs of economic weakness, and expectations for more ECB easing to combat deflation are pushing Eurozone government bond yields to record lows. The fact that the ECB may also start its own version of quantitative easing (while the Fed is winding down its bond purchases) is also causing a widening gap between U.S. and Eurozone bond yields. The green line in Chart 4 shows the 10-Year T-Note yield trading as low as 2.48% on Tuesday. It is in the process of testing possible chart support along its May low. The lower box shows how much lower comparable bond yields are in the Eurozone. France is yielding 1.51%, the Netherlands 1.31%, and Germany 1.12%. That's the lowest yield in German history. The spread between lower German yields and higher U.S. yields are at the widest level in fifteen years. Since money usually flows into higher-yield bonds, that makes the U.S. a better alternative than the Eurozone. That pushes U.S. bond prices higher and yields lower. The fact that Spanish yields (2.46%) have slipped below the U.S. is also pretty amazing. [Britain is the European exception. It's 10-year yield is higher than the U.S. at 2.55%. That helps explain relative strength in the pound and U.K. stocks]. The lowest box shows the Japan 10-Year yield at 0.52% which is the lowest in the world. It's no wonder that European and Japanese investors favor higher-yield Treasury bonds over their own lower yielding bonds.
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Chart 4
U.S. DOLLAR INDEX TURNS UP... With U.S. bond yields higher than most of the developed world (and with expectations that the U.S. will raise rates sooner than most), money is flowing into the higher-yielding U.S. dollar. Chart 5 shows the U.S. Dollar Index trading at the highest level in nearly six months on Tuesday after exceeding its June peak. That sets up a bullish pattern of "higher lows" and "higher highs" that started in May (when the Euro peaked). Most of the dollar gains since May have come against the Euro (3.2%). That's important since the Euro accounts for 57% of the USD. The dollar has gained ground against other currencies over the last month. Since July 1, the dollar's biggest gains have come at the expense of the Swiss Franc (2.2%), the Euro (2.0%), the Canadian Dollar (1.6%), the British Pound (0.95%), and the Japanese yen (0.74%). The weekly bars in Chart 6 show that the USD has also bounced off a major support line extending back to early 2012. That makes the current dollar rally more credible.
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Chart 5
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Chart 6
RISING DOLLAR MAY HURT GOLD ... Despite the fact that gold stocks have been the year's strongest stock group, the outlook for gold doesn't look that promising. That's mainly because gold usually doesn't do well when the dollar is rising. Chart 7 compares the trend of the U.S. Dollar Index to the price of gold since the end of 2010. The chart shows that they generally trend in opposite directions (which is one of the most reliable intermarket relationships). The dollar rally in mid-2011 coincided with a gold top. The dollar pullback in mid-2013 helped stabilize gold. Gold has lost ground this month while the dollar has been rising. Their 26-week Correlation Coefficient (below chart) has been in negative territory for most of the last three years (and is currently at a minus -0.44). While investors may turn to gold (or gold stocks) as a hedge against future inflation or a geopolitical shock, it's hard to imagine a major rally in gold while the dollar is rallying.
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Chart 7
FOOD AND ETHANOL PRODUCERS PROFIT FROM PLUNGING CORN PRICE... Some stock groups benefit from rising commodity prices (like gold and copper), while others profit from falling commodities. Corn prices (along with soybeans and wheat) have plunged to multi-year lows on good weather conditions and expectations for huge crops. That naturally benefits stocks that have to buy corn to do business. That would include poultry producers that benefit from reduced chicken feed costs, and firms that produce ethanol. Chart 8 shows the effect of corn prices on the trends of Archer Daniels Midland (ADM) and Pilgrim's Pride (PPC) since 2007. [ADM processes corn, wheat, and oilseeds to produce foodstuffs and ethanol. PPC processes and produces chicken products]. The chart shows that both stocks fall when corn prices are rising (like during 2008), and the period between 2011 and 2012 when corn prices spiked to multi-year highs. Since the middle of 2012, corn prices have crashed more than 50% and have fallen to the lowest level in four years. [Soybeans and wheat are also trading at multi-year lows). Since corn peaked in mid-2012, Pilgrim's Pride has gained 558%, while Archer Daniels Midland rose 91%. [Tyson Foods (TSN), another poultry producer, surged 166%]. At the same time, the S&P 500 gained a much more modest 42%.
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Chart 8
JAPANESE STOCKS BREAKOUT ON FALLING YEN ... While a falling Euro is hurting Eurozone stocks, the falling yen is having the opposite effect on Japanese stocks. That's not unsual since the yen and Japanese stocks usually trend in opposite directions. The weekly bars in Chart 9 show that the major drop in the yen during the fourth quarter of 2012 coinciding with a major upturn in the Wisdom Tree Japan Hedged ETF (DXJ). [That was due to Japan initiating a huge monetary stimulus program to combat deflation which included weakening the yen. A weaker yen is also good for Japan's export-oriented economy]. The orange weekly bars in Chart 9 show the Japanese stock fund breaking out of a bullish "symmetrical triangle" formation that's been in effect since last spring. The green bars show the yen bouncing since the start of the year which has kept Japanese stocks back. That's no longer the case. The daily bars in Chart 10 show the Japanese yen (green bars) falling today to the lowest level in three months (green circle). That's helping push the Japan stock fund to a new 52-week high. That makes Asia's two giants -- China and Japan -- two of the world's strongest stock markets. [The Wisdom Tree Japan Hedged Equity Fund (DXJ) is the preferred way to buy Japanese stocks since it hedges out the negative effect of a falling yen].
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Chart 9
