British Pound Headed For Par, But Not Now

• Long-term technicals for the pound
• Short-term technicals for the pound
• TIP of the day!
• The potential spoiler?

Long-term technicals for the pound

Chart 1 shows that the British Pound has completed a 30-year top. The price objective, calculated by taking the maximum depth of the formation and projecting it down at the breakout point, calls for a move to around 1.00, i.e. par with the dollar. In technical jargon, we say this is the minimum ultimate downside objective. Minimum because prices often move further than the objective, typically in multiples of it. Ultimate, because the downside target is not usually attained in a direct move. Rather, it takes the form of a zig-zag up or down, depending on the direction of the breakout. Another fact to bear in mind is that a pattern has to have something to reverse. In the case of the pound, where we are already close to record lows, achieving anything that is much below par could be problematic, but that still leaves the potential for another 25c or so, drop.

Chart 1

Short-term technicals for the pound.

That said, it seems that things are probably overdone on the downside for a while. That’s because Friday’s action triggered a frenzied news background, not only in the financial press but in the form of a Wall St. Journal editorial. We have even had the British Pound trade through “flash crash” treatment. Usually, that’s the kind of thing you see at or very near a crisis low. None of this invalidates the 30–year price formation, but it does suggest that we are likely to get a 'zag' before the next 'zig' down, sometime next year perhaps? After all, if everyone understands the bearish argument who is left to sell?

Chart 2

The idea of a rally is also supported by Friday’s price action. Chart 2, shows that it was an exhaustion day. These bullish one-day price patterns develop after a price drop, and the sharper the drop the better. On the day of the exhaustion, the price gaps lower, but by the end of the session, it ends higher than at the open. While the sellers come into the session very much in command, it is the buyers in the end who are victorious, at least as far as the intraday activity is concerned. To qualify for the “exhaustion” label, though, the bar must end with a gap. Some patterns, such as outside bars or two-bar reversals really give the trader the feeling that the buyer/seller relationship has changed. Exhaustion bars, on the other hand, are more subtle in their implications.  You can see how the feeling of exhaustion develops as the price drops slowly. Then it gradually accelerates to the downside until seller exhaustion sets in. Do exhaustion bars work every time? Nothing in technical analysis does, but as long as the price holds above the exhaustion day low, the odds favor it working. One other caveat relates to the fact that currencies are traded 24-hours. The US part of the session, which is what you see here, is not giving us the complete picture. However, reports tell us that the British pound price slipped considerably in the overnight session to $1.17, closing ($1.24) closer to the (&1.26) high, i.e. again indicating seller exhaustion, with a commensurate cleaning out of the stops.

Chart 3 shows that volume expanded fairly significantly last Friday, which is another indication that a pretty important battle was fought between buyers and sellers.

Chart 3

TIP of the day!

The bond market votes for inflation or deflation in its preference for inflation-protected or regular bonds. The inflation-protected bonds (TIP) offer a lower yield but a higher return in inflationary times because of the inflationary adjustment. The regular bonds (TLT) have a higher coupon but no inflation protection. The ratio between them (TIP/TLT) usually moves in tandem with commodities themselves, which is reflected in Chart 5 by the CRB Composite ($CRB). Interestingly, both series have started to edge through their respective resistance trendlines. Any additional strength will result in a decisive breakout.

If so, that would indicate that inflation sensitive industries, such as resource-based and materials will outperform their more defensive counterparts such as consumer cyclicals and staples, REITs and Utilities.

Chart 4

Two commodities and two commodity countries

Chart 5 shows the iShares MSCI Chile Capped ETF (ECH). Since the country is a major copper producer, it makes sense to compare its price to that of the red metal. As you can see, they are fairly compatible. It’s very difficult for ECH to avoid a drop when copper is weak. By the same token, a rising copper price certainly acts as a tailwind for the ETF. The blue dashed arrows show that ECH has a tendency to lead copper, so the fact that the two (AB) dashed arrows are moving in opposite directions with the ECH leading higher, is a positive factor. Note that ECH also has a bullish short-term KST. If commodities, including copper, move to the upside, as I expect, ECH ought to benefit as well.

Chart 5

Chart 6 goes through a similar exercise, but this time between the Brent oil price and the Global X MSCI Norway (NORW). In this instance, both series are breaking out from large, inverse head and shoulder formations, which suggests that both oil and its producer Norway are headed for better times.

Chart 6

The potential spoiler?

There is one factor that could prevent such a scenario and that’s the US Dollar, as featured in Chart 7. Most of the time the DB Commodity ETF and the Dollar Index move in opposite directions. However, at present both look to be close to an upside breakout. Historically, there have been periods when commodity prices and the dollar have moved in the same direction, but these are very much the exception.

Chart 7

However, when we consider Charts 8 and 9 it is not improbable that we might have a more broadly based commodity bull market on our hands. These charts suggest that the CRB Composite, when expressed in euro and yen, may be about to complete major inverse head and shoulders patterns. If that proves to be the case, and the dollar based commodity indexes also break to the upside we could well have a global commodity rally on our hands. Given the previous 5-years of declining prices market sentiment is certainly set up for an unexpected outcome.

Chart 8

Chart 9

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.