FALLING DOLLAR IS BOOSTING COMMODITIES -- THAT'S POTENTIALLY INFLATIONARY -- WHILE A RISING EURO IS HOLDING EUROZONE INFLATION DOWN -- A STRONGER EURO IS STARTING TO WEIGH ON EUROPEAN STOCKS -- A LOOK AT GOLD IN DIFFERENT CURRENCIES
CURRENCIES HAVE AN IMPACT ON INFLATION RATES... Persistently low inflation is worrying central bankers around the globe. Even the Fed has expressed more concern of late. Central bankers in Australia, Canada, Europe, and Japan have also mentioned low inflation as restraining them from abandoning their ultra-loose monetary policies. So far, only the Fed and Canada have actually raised rates. Whether they'll do it again largely depends on an uptick in inflation. Other central bankers have only started talking about tapering or raising rates. It all comes down to inflation. Which brings us to the subject of currencies. The direction of a currency plays an important role in determining that country's (or region's) inflation rate. As a rule, a weak currency is more inflationary. A rising currency is less inflationary. We can see that effect more easily by using commodity prices as a proxy for inflation. A falling dollar usually boosts commodity prices. That's because global commodities are quoted in dollars. But it's not that simple. Foreign traders often look at commodities in terms of their own currencies. Because that's what they use to buy them.
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Chart 1
COMMODITIES QUOTED IN EUROS ARE LAGGING BEHIND... The green bars in Chart 1 above plot the Reuters/Jefferies CRB Index (in dollar terms), while the blue line shows it quoted in euros ($CRB:$XEU). It's clear that the blue line is rising a lot slower than the green bars. The reason is simple. Commodities quoted in a weaker dollar will always rise faster than commodities quoted in a stronger currency like the euro. The CRB Index is down nearly -5% since the start of the year. Quoted in euros, it's down nearly -16%. The difference between the two is an 11% advance in the euro against the dollar. Since late June, the CRB has gained nearly 9% versus a gain of less than 4% when quoted in euros. That was due to a 5% gain in the euro versus the dollar. So here's the main point. By helping boost commodities (and prices of imports), the falling dollar may produce enough of a bounce in inflation to allow the Fed to raise rates later this year. A rising euro, however, restrains gains in commodity and import prices which would hold inflation down. That could make it tougher for the ECB to start tightening monetary policy. The same is true of other central bankers whose currencies have risen against the dollar. The ultimate result could be a more hawkish Fed and more dovish foreign central bankers. That in turn could boost the dollar. I'm using the euro in this discussion because it has the biggest impact on the Dollar Index (57%) and has the biggest rise of the six foreign currencies in that index. Since it's so important, let's take a look at it.
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Chart 2
EURO STILL IN A MAJOR DOWNTREND... The monthly bars in Chart 2 show the euro still in a major downtrend. The falling trendline extending back to 2008 is well above the current price. The flat red trendline shows potential resistance along the 120 level which marks the lows formed in 2012 and 2010. Before it gets there, however, it still needs to clear its mid-2015 peak. The weekly bars in Chart 3 show the euro trying to clear the summer 2015 peak near 117. A decisive close above that barrier could push it to the 120 resistance line shown in Chart 2. The 14-week RSI line (above chart) is at the most overbought level in ten years (75). My Wednesday message showed the Dollar Index nearing a test of potential support at its 2016 lows. The strong euro may be having a negative impact on eurozone stocks. Just as a weak dollar has boosted the revenues of large cap multinationals here, a rising euro could be weighing on export-oriented eurozone stocks. Chart 4 shows the EURO STOXX 50 Index losing ground. That index includes the fifty largest and most liquid eurozone stocks. The index is down again today. Most European stocks are in the red, as are most global stocks. Late week selling in technology stocks is having a negative impact on several Asian markets.
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Chart 3
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Chart 4
GOLD IS RALLYING IN DOLLAR TERMS... The price of gold is trying to make a comeback. The weekly bars in Chart 5 show the Gold SPDR (GLD) climbing to the highest level in more than a month. Most of its 2017 gain is tied to the falling dollar. Chart 5 shows the gold upturn at the end of 2016 coinciding with a peak in the dollar (green arrow). There's a cautionary note, however, for gold bulls. For a gold rally to be sustained, it has to do more than rally in dollar terms. It has to rally against foreign currencies as well. The last major rally in gold took place from 2002 to 2012. Chart 6 shows that gold rallied in dollar terms (green line), in euros (blue line), British pounds (red line), the yen (orange line) and the Canadian Dollar (not shown). That's not the case right now.
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Chart 5
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Chart 6
GOLD QUOTED IN OTHER CURRENCIES ... Chart 7 shows the 2017 trend of gold in five different currencies. And the lines paint very different pictures. Gold is doing best this year against the dollar (10%) and yen (4%) because they're two of the year's weakest currencies. Gold, however, is weaker against the British pound (3.5%) and the Canadian Dollar (1.8%). It's actually lost ground against the euro (-1.4%). If you view gold as a hedge against inflation, the lines in Chart 7 show the impact that currencies have on its direction. And how stronger currencies are holding it back, especially in the eurozone. The main point of Chart 7, however, is to show that gold isn't exactly rising when looked at in foreign currency terms. That diminishes its bullish potential.
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Chart 7
TWO VIEWS OF GOLD... The weekly bars in Chart 8 suggest that gold may be forming a major bottom. It still, however, has a long way to go to clear the trendline drawn over its 2014/2016 highs. Gold usually needs a more inflationary environment to thrive. It usually also does better when stocks are in decline which isn't the case right now. [Next year, however, may be a different story]. But gold also has to start doing better versus the euro. The blue bars in the lower box in Chart 8 show gold trading lower against the euro this year. Its proximity to the rising three-year trendline, however, suggests that gold may start finding support against that currency.
