 Currency Countertrends
Adam Hamilton
Archives
January 31, 2005
The recent technical reversals
in the dollar, euro, and gold are spawning a lot of discussion
in the markets these days. Sizable currency moves broadly impact
most major countries and markets in a myriad of interrelated
ways, so investors and speculators really need to pay careful
attention.
These reversals now underway
are all countertrend moves. In each case the currencies
are moving opposite to, or counter to, the direction their primary
long-term trends have traveled over the last few years.
The mighty US dollar is in
a primary bear
market. From July 2001 to December 2004 it has fallen by
an amazing 33% bear to date. It is appalling that the average
American who pays no attention to these things has no idea that
the international purchasing power of his income and wealth has
been cut by a third in only the past few years. Ouch.
The main beneficiary of the
dollar's bear has been the euro, which is enjoying a powerful
primary bull market. From October 2000 to December 2004 the once
ridiculed composite fiat currency has powered a dazzling 65%
higher! This bull provides a compelling disincentive for savvy
European investors to buy dollars to invest in the States, since
the falling dollar can be repatriated into fewer euros with each
passing year.
The dollar's weakness is also
driving the initial currency stage of our primary gold
bull. From April 2001 to December 2004, gold in US dollar
terms soared by a breathtaking 77%. This number alone is interesting
as it far exceeds the dollar's 33% drop and should help put to
rest perpetually popular ideas among fringe gold investors who
believe gold will just tread water relative to the dollar's fall
without earning real gains.
Now these respective dollar,
euro, and gold primary trends are all over three years old, which
puts them solidly into the fabled annals of seculardom. A secular
trend is a powerful long-term market movement driven by underlying
fundamentals. Once secular trends start, they can run anywhere
from a half decade to nearly two
decades so they must be respected. Only radically
changing fundamentals can end a secular trend.
Since last month, we have witnessed
countertrend reversals running 4.2%, 4.8%, and 8.1% respectively
in the dollar, euro, and gold. Compared to their secular trends
to date, these reversals represent relatively trivial retracements
of small fractions of their entire secular moves. In addition,
these countertrend reversals have only run for an average of
5 weeks compared to an average of 45 months for the primary
trends.
Which trends are more important
and likely to persist? The 5-week countertrend reversals or the
45-month primary secular trends? Obviously the longer a trend
lasts, the higher the probability it is being driven by powerful
underlying supply-and-demand fundamentals which are very slow
to change. Conversely the shorter the trend, the more likely
it is little more than fleeting technical noise.
Countertrend moves, whether
they arrive in the form of corrections in secular bulls or bear-market
rallies in secular bears, are necessary to rebalance sentiment.
In bull markets popular sentiment periodically waxes too ecstatic,
so a correction bleeds off the speculative excesses to keep the
bull healthy. In bear markets speculators periodically grow too
pessimistic and scared, so bear-market rallies are necessary
to rebalance sentiment to neutral.
Temporary countertrend reversals
are completely normal and should be expected in all markets dominated
by secular trends. These moves lead to common mistakes made by
speculators who haven't conditioned themselves to expect
the periodic countertrend reversals.
Some speculators don't take
the prospect of countertrend reversals seriously enough, so when
they inevitably happen these speculators grow flustered. When
they see their primary trend not running arrow straight into
infinity, they assume that they were wrong and they exit a secular
trend too early, often leaving in disgust. Some even blame others
for these inevitable reversals, assuming some shadowy syndicate
of insider traders is out to personally destroy them.
This leads to another mistake,
taking a temporary countertrend reversal too seriously. If speculators
don't expect these moves, their arrival can lead to deep worries
that their primary trend is over. They assume the worst, that
a major secular reversal is underway. But secular bulls and secular
bears don't end very often, and when they do it is always on
major changes in underlying fundamental conditions. Technicals
alone won't do it.
The happy medium navigating
between these mistakes is just to expect periodic countertrend
reversals in any secular trending market. Corrections in bulls
and bear-market rallies in bears are inevitable and healthy,
so the wise course of action is to expect them, ride them out,
and continue betting with your primary trend until its
driving underlying fundamentals radically change.
As a gold investor, I find
myself particularly interested in how our current countertrend
moves are affecting the gold market. Gold is money, the
ultimate historical currency over six millennia, so it does tend
to move in parallel to other major currencies. In fact, in Stage One
of a major secular gold bull, fiat currency devaluations are
its major driver.
Since the dollar, euro, and
gold are so interrelated as competing currencies these days,
I don't think they can be studied independently. If you want
to know how long their current countertrend reversals are likely
to last and at what levels they are likely to end, you really
need to study all three at once. This holistic approach
is as important to dollar or euro speculators as it is to gold
speculators.
Our three charts this week
should all be viewed at once as they compare the dollar, euro,
and gold over the past 17 months or so. During this time each
currency has witnessed three major reversals, two countertrend
and one ending a temporary countertrend move to rejoin the primary
trend. The fascinating thing to observe is the timing, as all
three currencies tend to reverse at roughly the same times. Vertical
blue lines through each chart highlight these reversals so they
are easier to compare among the charts.
These charts also highlight
the Relativity
analysis for each currency, or the absolute distance away from
their respective 200-day moving averages that they tend to stretch.
This also gives us important clues as to when countertrend reversals
are likely to end so the primary trends can reassert themselves.
Relative extremes almost always match major interim highs and
lows that mark short-term turning points.
As you examine all of these
charts at once, there are a few things to note. First, the dates
of the last three reversals are nearly identical in all but one
case where they were merely similar, which I will discuss below.
Neither the dollar, euro, nor gold can be studied effectively
from a trading standpoint by ignoring the other two currencies.
They are all interrelated.
Second, when a currency is
moving with its primary secular trend, bull or bear, it
tends to diverge away from its black 200dma. But when it enters
a temporary countertrend reversal, either correction or bear-market
rally, it tends to converge back to its 200dma. The raw degree
of these periodic 200dma divergences and convergences is noted
by the red relative readings that show each price as a constant
multiple of its 200dma over time.
Finally, while each of today's
countertrend moves is well underway, they tend to struggle a
bit when they hit the first support or resistance line extended
from the last move with the primary trend. In the dollar's case
above, the dollar bear rally is now struggling to get over its
lower support line established in the second half of 2004.
Not surprisingly, the peaks
and troughs of this euro chart match the dollar's almost exactly.
Just as the dollar is now struggling with an extended support
line from its last downleg, so is the euro now bouncing off of
an extended resistance line from its last upleg. Once these key
technical levels are overcome, the countertrend moves should
continue until they fully run their courses with each currency
back near its respective 200dma.
The January and May gold reversals
perfectly match those in the euro and dollar above, but the December
one arrived a few weeks early. I suspect this was because of
the gold ETF-driven selling panic that hit gold early last month.
The gold ETF's competitors launched a preemptive strike across
its bow by actively undermining its reputation via strategically
released half-truths and exaggerated conclusions designed to
scare away investors.
If you are interested in understanding
the ETF-driven gold selloff in detail, I discussed it extensively
in the current January issue of our Zeal
Intelligence newsletter. Without the surreal ETF-driven events
of early December, I suspect gold would have rallied right into
the end of the month and hit its relative neutral signal above
1.14 within days of the reversals in the dollar and euro. The
ETF mini-panic just accelerated the inevitable reversal ahead
in time by a few weeks.
Once its countertrend reversal
commenced though, gold, like the dollar and euro, initially bounced
off of its extended resistance line from its previous upleg in
the second half of 2004. After this zone failed, gold soon fell
down to its extended support line from the last upleg, where
it is struggling along today. It will probably have to converge
even closer with its 200dma now near $411 before its current
temporary correction ends.
Looking at these three currencies
primarily from the perspective of a gold investor and speculator,
when they are all considered together they seem to paint a much
clearer picture of what to expect in the next couple months than
gold alone. This is easiest to understand if we study the last
major countertrend reversal in the currencies, from January 2004
to May 2004.
A year ago this month, the
dollar, euro and gold were all stretched far away from their
respective 200dmas. The dollar, since it is in a primary bear
market, was stretched way below its 200dma, actually approaching
only 0.90x this key technical line. Meanwhile the euro and gold,
both in primary bull markets, were stretched far above
their respective 200dmas. The euro traded over 1.11x its 200dma
while gold went 1.15x as high.
But, as is no surprise for
diligent students of the markets, any secular trend can only
diverge so far away from its 200dma before a temporary countertrend
reversal to rebalance sentiment becomes inevitable. On the very
same day last year, January 9th, the dollar, euro, and gold all
reached their 200dma divergence limits simultaneously and began
converging with their 200dmas in unison.
If you strive to look for these
reversals in advance so you can trade them profitably, the interesting
thing to note is that these currency countertrend moves were
anticipated. I wrote an
essay published the same day of this reversal last January
that warned, "The US Dollar Index really looks like a major
countertrend rally is imminent and due. And if a bear-market
rally in the dollar launches, for any reason, odds are that gold
is going to get hit over the short-term. Get ready!"
These normal, healthy, and
expected countertrend currency moves ran about four months into
May before they reached maturity. By early May the dollar, euro,
and gold had all converged with their respective 200dmas, signaling
that their reversals were nearing an end. This too was expected,
as I wrote
in late April, "Another major gold upleg appears to be on
the very verge of launching, but only the decisive and brave
will seize today's awesome opportunity to saddle up and ride
it. Get long now!"
Once again the dollar, euro,
and gold, as competing global currencies, all exited their countertrend
reversals of early 2004 within one day of each other in
May. Their respective sentiment-neutralizing 200dma convergences
complete, their 200dmas began to diverge again as their primary
secular trends reasserted themselves. The dollar's primary bear
market continued to new bear-to-date lows while the euro and
gold bulls marched right on to fresh new bull-to-date highs.
Now in light of this strong
recent, and indeed long-term,
precedent of the dollar and euro/gold to move in resolute lockstep
opposition, doesn't it make sense to expect this relationship
to hold for this current countertrend reversal? I don't know
of any reason to expect it not to hold, unless gold suddenly
launches into Stage
Two and decouples from the dollar on global investment demand.
This Stage Two transition we
have so eagerly awaited certainly could happen at any
time, but betting on this inherently unpredictable event happening
in any given month is a low-probability-for-success gamble. Yet,
I hear many gold investors and speculators who are making this
very bet. They are continuing to try and call an interim bottom
in gold, and the end of its countertrend reversal, before the
dollar and euro reversals fully run their own courses. Possible,
but not probable.
Since the last major gold shifts
from upleg to correction mode or vice versa have usually happened
to the day that the dollar and euro made their own reversals,
it seems prudent to look for this same simultaneous currency
convergence to again come to pass before gold is ready to enter
its next major upleg. Until the dollar, euro, and gold all complete
the necessary convergences with their own 200dmas, it makes little
sense to get excited about a major interim bottom in gold.
Today's currency 200dma convergences
are all progressing nicely, but to different degrees. The dollar
has traded as high as 0.964x its 200dma so far, but as our red
short band in the first chart above shows it should exceed 1.00x,
or travel above its 200dma, before its bear rally is ready to
give up its ghost. In terms of its Relativity band defined by
the green and red Relative Dollar long and short indicators on
its chart, the dollar bear rally is barely halfway into its relative
channel, or halfway complete.
The euro is in the same boat,
about halfway through its relative channel with a correction-ending
relative target just at its 200dma, or 1.00x. Correction to date
the euro has traded as low as 1.039x its 200dma, so it still
has a ways to go to hit it. With both the dollar and euro only
halfway through their expected countertrend reversals, odds are
gold still faces some weakness or at least continuing consolidation
ahead.
Gold, however, thanks to the
ETF-driven selling panic in early December, is probably 80% through
its expected correction in relative terms. Its red rGold line
above has fallen most of the way through its relative trading
channel, but it still has a little ways to go yet as gold should
bottom under 0.99x its 200dma before launching a dazzling new
upleg. Correction to date the lowest it has traded is 1.019x
its 200dma.
With gold's correction already
so advanced in expected 200dma-convergence-distance terms, it
is easy to understand why gold investors and speculators are
chomping at the bit to call a gold bottom and throw long with
a vengeance again. Yet, the parallel dollar and euro countertrend
reversals are not that far along yet leading me to believe we
are in for more dollar strength and euro weakness, which is not
favorable for gold.
Gold will probably grind sideways
and a bit lower to its 200dma while the dollar bear rally and
euro correction continue in the next couple of months. I fully
realize this is not what gold investors want to hear, but the
currency connection remains so strong in gold trading that probabilities
favor this course of action. Gold's next major upleg will inevitably
come, but probably not until all three currency countertrend
reversals fully converge with their 200dmas.
If you are interested in deploying
capital in this next gold upleg when the time looks right, please consider subscribing
to our acclaimed monthly Zeal Intelligence newsletter. Over the
last couple months we have painstakingly researched all of the
major gold mining companies as well as over 50 juniors so far.
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In addition, and maybe more
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By the time to redeploy into
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of these relative currency charts that are now updated every
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The bottom line is temporary
currency countertrend moves are necessary, healthy, and should
be expected periodically. They deftly bleed the air out
of sentiment imbalances that breed when secular trends diverge
too far from their anchoring 200dmas.
Once these countertrend reversals
are underway though, they tend to run until all three major currencies
fully converge with their own 200dmas. The dollar bear rally,
euro correction, and gold correction are likely to persist until
all three currencies reach the fully converged point where
they can majestically launch back into their primary secular
trends.
And since gold still seems
to remain firmly entrenched in the Stage-One currency-devaluation
phase of its secular bull, it seems prudent to not expect a major
interim gold bottom totally independent of a major interim dollar
top and euro bottom. All three currencies must be considered
together as long as they continue to trade in lockstep
with each other.
January 28, 2005
Adam Hamilton, CPA
email:
zelotes@zealllc.com
Archives
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