Monday, March 17, 2008

The Buck Stops Where?!

This long-term head-and-shoulders reversal suggests that the US dollar – measured against the currencies of its trading partners – has just begun a collapse toward the 40-point level. One of the most common reversal formations, the head-and-shoulders pattern offers a rough measure of how painful the coming move will be. From the time the pattern broke through neckline support (mid-year 2007), you can project the coming price decline. First, measure the distance from the neckline to the top of the head (41 points). Then subtract this number from the neckline (81) to derive the 40-point target. The only bright spot in the US dollar gloom is that, after the breakdown, head-and-shoulders patterns tend to return to the neckline before resuming their downward movement.
By Peter McKenzie-Brown This is the third column in a series describing the relationships among the prices of gold, oil and other financial instruments. The first concluded, in part, that the price we are paying for gold is directly related to the price we are paying for oil, and that gold's fast-moving price reflects a rapidly deteriorating situation in the petroleum industry. The second column used technical analysis to show the inverse relationship between stocks and commodities. When you are in a bull market for stocks, commodities decline, and vice versa. In this third and final commentary, I want to use technical analysis again, but this time to show how the fall of the US dollar fits into the picture. The chart above shows the volatility of the greenback over the last 25 years. It also shows the very worrying head-and-shoulders reversal pattern, which developed during a 15-year period. Why is the US dollar in such deep doodoo? Let me count the ways: Recession; rising inflation; trade deficits; government debt; consumer debt; a credit crisis; a house-price crisis; a banking crisis; dependency on foreign oil; huge reserves in countries (China, Russia, Saudi Arabia) that have deep-seated issues with the US, and have recently been investing in other currencies to get better returns; US dollar outflows to invest in overseas assets; the shift of manufacturing and many services to overseas locations; an economy 70% dependent on consumer spending, which is drying up; a steady stream of interest rate cuts from the Fed. The blood-letting isn’t over yet, and that has important implications for both gold and oil. This chart shows how, like the Dow Jones Industrial Average, gold and oil prices tend to move counter to the value of the US dollar – the currency in which most international commodities are now priced. Following are a couple of even more dramatic pictures of the same thing. The two small charts factor in the relative value of the dollar directly. You can click on the charts to see them full-size, or view them and other graphics from this series, updated, by clicking here. The Partners Strike Back: These charts are based on a measure of the greenback known as the “trade-weighted” dollar, because it compares the US dollar to the basket of currencies – Euros, pounds, yen, Canadian dollars – used by America’s major trading partners. If the greenback is collapsing against those currencies, how will the trade-weighted partners respond? We Canadians would just love a rising loonie if all we wanted to do was buy real estate in the cratering US market. Our dollar has risen by about one third in US dollar terms in the last year, so American goods and services are much cheaper than they used to be. However, Canadian goods and services are now more expensive in the US, and that has made it much more difficult to sell to American buyers. The same is happening in the economies of East Asia and Europe. The rest of the world could respond to this dollar debacle in a couple of ways. One possibility is “competitive debasement” of national currencies. In this scenario, countries hurt by the falling buck would find ways to shore up the greenback by debasing their own currencies. Could that work? For a while, perhaps. However, as long as US dollar fundamentals are bearish, the American currency will continue to slide. As they say, you can put lipstick on a pig, but it will still be a pig. The world's multi-trillion dollar foreign exchange markets can only be fooled for so long. Another response to the declining dollar has already begun. Europe, Japan and China have begun a shift away from reliance on US consumption for their trade. For example, in 2000 30% of Japan's exports went to the US; last year it was only 20%. China now has more than 300 million middle class people with the savings to afford a good standard of living (think of the American dream 50 years ago), and they are ramping up consumption. Europe and China are each other’s largest trading partners, and the beat goes on. Can you think of any historical analogues to this situation? Perhaps the best is that of the British Empire, which began to lose its global dominance 90 years ago. Britain lost its reserve currency status as the US rather than England began to serve as the workshop of the world. Its financial power and military might soon followed. What country could be in a position to take over from the US? China? Could be. If you believe the flight to gold is a flight to value, safety and security during turbulent times, the following chart suggests that more big moves lie ahead. The chart shows two cup-and-handle formations since the famous gold spike of 1980. For technicians, cup-and-handle formations are among the most powerful indicators of upward movement. The green box shows the handle of a formation which developed between 1996 and 2005. After that handle broke upward, gold prices formed a second handle (blue box) which has now also broken upward. This extra-large cup-and-handle formation - 28 years in the making - is a powerful indicator of more upward movement to come. Remember: gold is a proxy for most commodities, so this pattern is also bullish for petroleum.
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