Currency update week ending 15 August 2008

Another wild week in the currency markets with the US dollar showing an unbelievable amount of "relative strength".

The reason I use this term is because it must be understood that there is no such thing as a "rising" currency. All paper currencies fall continuously due to ongoing monetary inflation (which is primarily a function of central bank currency creation). It is the degree to which one currency is falling in relation to another currency that determines its relative value.

It is useful to think of currencies as bricks all thrown from a tower of infinite height. As they accelerate downwards, they maintain the same relative position to one another.....but they are all falling none the less. If you were standing on one brick you would see the brick beside you maintaining the same relative position (and thus neither "rising" nor "falling". However, should one brick hit some denser air or collect something on it that changes it's frontal area, it would fall at a slower pace relative to it's neighbors. As such, it would be viewed as "rising" if you were standing on the brick that was falling beside it. This is how it is with currencies.

The only "brick" that maintains a steady level over time is gold. The reason for this is because throughout history it has been accepted as a form of currency and cannot be "printed" or reproduced. This allows it to maintain a "constant" value over time while the currencies it is priced in continue to fall over time. This is the reason why I maintain a set position in physical gold in my own portfolio irrespective of the day to day movements in the various currencies relative to gold.

The degree to which the USD has "risen" in recent days is almost unprecedented (the British pound is on its longest streak of consecutive losing trading sessions in 37 YEARS!). This is a very unusual event and it appears many were on the wrong side of the "short USD" trade and are now covering positions. The question is where do we go from here.


First chart is the 6 month daily candlestick chart (click on all charts to enlarge):



As shown last week, the USD has been on a parabolic ride since mid July. Since breaking above the previous level of resistance @ 74.31 it has been just about straight up.

From a technical perspective all indicators are bullish for the USD with the exception of the RSI(14) which is massively overbought and in need of a downward price correction.


Next chart is the 2 year daily candlestick chart to give a somewhat wider perspective:



It can be clearly seen how the level of 74.31-74.48 has fallen over the past 6 trading sessions. Also it is evident the longer term downtrend line I spoke about previous @ approximately 76.50 has been broken to the upside.

The MACD reflects the degree to which momentum has changed in the USD. Note the 2 previous peaks in momentum (Oct 2006 & Dec 2007) and how this current run up has blow well beyond the previous levels of positive momentum.

The next level of key resistance is now @ 77.04-77.85.


The next chart is the 3 year weekly chart which I use to identify medium term currency trends:



This chart turned USD bearish in April 2006 when the MACD crossed below the zero line. The USD has been in a steady decline ever since.

It is clear the trend line that has been in place since 2006 has been violated to the upside. Also note the positive ADX (14) cross (the first since 2005) and the MACD rising to attempt to cross the zero line. It has not crossed yet (closed Friday @ -0.021) but with the current momentum it is obvious this chart is indicating a longer term bullish trend in the USD has begun.


Next chart is the 10 year daily chart:




There are number of important things to note on this chart:

The key to note is price has broken above the trend line that was established at the beginning of 2002. This is a very significant event.

The market is severely overbought as indicated by the RSI (14) and in need of a pullback. In fact, it is more overbought now than at any time over the past 10 years (as indicated on the chart).

It is common to see price retrace a breakout to retest the trend line from above. As such, I expect the USD to soon reverse and hit the downtrend line from above. This would alleviate the overbought condition of the RSI and either:

a) set up a new up-leg and a long term bull market in the USD, or

b) fail and re-establish a new down trend.

It is too early to tell which will happen. What is certain is that the current pace of advance is unsustainable and the USD will fall in the near future. The question as to whether it is a new uptrend or a new downtrend will be answered when it tests the trend line.


The next chart is the Point and Figure charts for the USD. The first is the short term 0.1 box chart:



This chart went bullish on a price break of 72.50. Based upon the structure of the advance, it projected a price target of 74.50. This price has been exceeded by a huge amount and therefore it indicates the USD is in need of a short term correction.


The second Point and Figure chart is the Traditional with a more medium to long term view:



This chart went bearish back in April 2006 and has yet to turn back to bullish. When it turned bearish it projected a price target of 76.00. During the course of the decline the USD fell well beyond this level indicating it was oversold and due for an upward price correction. This has now occurred.


Next charts are the 3 year weekly charts of the Euro, British Pound and Australian Dollar with MACD buy/sell signals indicated:

Euro:



The Euro went to a sell signal this week. While there is a chance of a bounce due to the oversold condition, the trend from here is down.

British Pound:



The Pound has been on a sell signal since Dec 2007. Nothing has changed.

Australian Dollar:



The Australian Dollar is still technically on a buy signal.


The last chart is a long term chart of gold relative to other common currencies:



Gold has been on a nice uptrend since 1971 when the US came off the gold standard (allowing free printing of currency without physical backing of gold bullion). It has recently broken its 65 month moving average and can be considered in "correction" mode. It would not be a good time to be in gold if you were using it as a speculative investment tool.

However, if you are not a speculator and are a more long term "buy and hold" type of investor, gold may be worth looking at. There is an interesting calculator produced by the US Federal Reserve to calculate the value of the dollar. Let's say it is 1971 and the US is going off the gold standard. I have 2 possible strategies; take my $35 in US currency and put in my mattress or take my $35.00 and buy one ounce of gold bullion and put it in my mattress.

The results:

1) Today I go to spend my $35.00 in US currency. What will it buy today? It will buy $6.57 worth of goods and services.

2) Today I go to spend my 1 oz of gold. What will it buy today? It will buy $792.10 worth of goods and services.

Where do you think I would want my "spare" cash that is not invested in Real Estate, Stocks, Bonds, etc? Where do I put my "emergency" cash.......gold. It is not a "buy and sell" investment; to me it is a "buy and buy and buy some more investment" that provides the only protection from the ravages of inflation over time. This is why I believe everyone should have a small portion (minimum 5%) of your entire portfolio in gold.

Just some food for thought.