Thursday, February 18, 2010

Dollar and Euro Review

Feb 18, 2010

A quick glance at the Euro reveals that it’s putting in broad based top formation; it has been unable to trade past 150 for any decent period of time. It is also putting in a bearish rising wedge formation. A break below 148 for 3-5 days in a row should take it down to the 144 ranges. The next step would be to trade below 144 for 3 days in a row or close below it on a weekly basis. If it achieves this, the next target becomes 141, and it could potentially spike all the way down to the 138 ranges before stabilising. Global Pulse Nov 2009.

The dollar has broken out very strongly from this falling wedge formation. A strong break out is usually a very good sign that the trend is going to last a few months. Conversely, in the picture below we see that the Euro has broken down very rapidly after putting in a rising wedge formation. Global Pulse Dec 22, 2009

The Euro exhibited further weakness by its inability to rally to 146 after testing 142. After trading as high as 145 it rapidly broke down and dropped all the way down to 140 before stabilising. This violent action indicates further weakness in the Euro and is also a signal that it could now potentially trade below 130.

The dollar, on the other hand just achieved a critical mile stone by closing above 78.50 on a weekly basis. This is the first strong signal that the dollar could potentially mount such a strong rally that it could/might catch both the bulls and the bears off guard. The dollar has generated a buy on the weekly, daily and hourly time frames; if by some miracle it generates a monthly buy signal (this based on 9 years worth of data and each bar represents one month worth of data), it could change the upside targets dramatically. However, we do not want to get ahead of ourselves as new monthly signals are usually a rare development. The euro, on the other hand has generated a sell signal on the weekly, daily and hourly charts.

The final development would be a monthly close above 81 for the dollar index; if this comes to pass it should lead to a test of the old highs with the possibility of spiking as high as 91 before a top in is place..

A monthly close below 140 for the euro would be negative development and signal that the Euro could now potentially trade all the way down to 125.


The Euro is facing a host of problems and rather than repeating them all we have attached an extract from the Jan 5th market update titled “Euro woes” that was sent out to our subscribers that covers this topic in detail.

In terms of the dollar we can make the following assertions

Technical picture

Multiple indicators have generated a buy signal and up until very recently the dollar was extremely oversold. We also have the dollar carry over trade, if this starts to unwind in the same way the Yen did, it could lead to huge spike upwards as was the case with the Yen. In the Yen carryover trade, the New Zealand dollar was the beneficiary as individuals borrowed in Yen and jumped into New Zealand dollars. Right now most of the competing currencies are the beneficiaries of the US carryover trade, but the main one is the Euro. Thus if the unwinding process starts to gather steam the Euro, Franc, Australian Dollar, Canadian dollar, etc., could experience severe pull backs.

Mass psychology perspective

The dollar is still universally despised and so when an investment is despised to such an extent, mass psychology indicates that a strong reversal is usually close at hand. From hating the dollar the majority will slowly start to embrace the dollar and this will be what drives it even higher. Unlike contrarian investing mass psychology does not advocate taking a counter position to the masses the moment they become bullish on an investment. When they change and embrace an investment, there are 3 stages, the Luke warm embrace, the full embrace and then the euphoric embrace. We will soon approach the Luke warm stage so potentially there is still quite sometime before we hit the euphoric stage. It’s only at the euphoric stage that we will start to look for an exit.

Now normally the above two developments are sufficient for us to jump into an investment. However, this time the fundamentals are also against the Euro and instead of repeating them all over again. We are just going to post an excerpt from the Jan 5 market update below.

Euro Woes

The European Union established the growth and stability pact which imposed the following two conditions on all members

1) Deficit spending cannot exceed 3% of the GDP

2) Total Government debt should not exceed 60% of GDP

The table below clearly illustrates that many of the members are blatantly ignoring these rules.


Budget Deficit as % of GDP

Debt as % of GDP













Spain’s budget deficit could reach 90% of GDP by 2011, currently it is roughly at 60% and rising, so we have yet another contender to join the list of troubled nations. S&P has already downgraded Spain’s sovereign AAA credit rating. In fact, at this point Germany is the only country in the EU that deserves the AAA rating, the rest all face varying degrees of trouble.

Germany the head honcho is in no mood to lend money or help its fellow members as they have their own problems. Now a strong currency makes it hard for struggling countries to make their exports attractive by devaluing their currency. Under the one currency umbrella, they no longer have this option. For example, Italy had a history of systematically devaluing the lira when faced with tough economic conditions; they no longer have this option now that they are part of the Euro. Thus the next step is to simply openly flaunt the rules. If no punishment is forthcoming for breaking these rules, then there is nothing to stop other members from doing the same.

Thus there is a very good chance that something could crack here and that the Euro might not end up being as safe as so many make it to be. While the US has problems, the problems facing the EU are starting to look even more daunting. Look at the table above all 4 nations are openly flaunting the rules laid by the growth and stability pact, actually when we add Spain to the list it the count rises to 5.

This situation is going to create rifts in the EU as weaker nations now have to adhere to a fixed standard, and as a result they are going to continue to blatantly ignore these rules. This in turn is going to seriously start to aggravate the larger stronger players such as Germany and France, which could possibly lead to the one of the following outcomes.

Some members could be kicked out

Members could start to openly revolt against these rules and make demands to ease them or ask for lengthy time extensions before coming into compliance with these rules.

Either of the developments could have a very strong negative impact on the Euro. So when we look out the window it appears what we stated many times in the past might become a reality. “Every currency is rotten” and the rats are jumping from one sinking ship to another. We are also very close to entering competitive devaluation stage (better known as the devalue or die era) where every nation in order to gain an exporting edge starts to devalue its currency.

Thus individuals should not smugly gloat over the dollar’s demise, for they might be missing the real trouble that is taking place in their own backyard. This problem facing the EU is another reason why the dollar could potentially mount a stronger rally than most expect and why it might even potentially surpass all our posted targets. When the ship is sinking panic takes over and people jump before they look. Thus if anything out there makes investors feel skittish about the Euro, it could potentially trigger a mad rush for the exits. Are we saying this is definitely going to occur? No we are not but given the large deficits 5 members in the EU are running; it’s safe to say that all is not well and that the situation could take a turn for the worse very rapidly. Greece could turn out to be another Iceland, if they do not get their act together very very fast.

The US dollar for all its current woes is at least backed by the full faith of the US government; the Euro in contrast is backed by nothing. No one nation backs it, it's backed by a group of nations whose economic conditions could/might force them to eventually abandon the Euro (strong examples right now are Greece and Italy, Spain and Portugal are not far behind). Going forward the currency markets are going to become increasingly complex and entangled.

The only real competition to the dollar is the Euro and the following two articles make a fragile situation appear even more fragile.

The only real competitor right now to the dollar is the Euro and the Euro could be in trouble. Moody’s recently made the following comments on two key members.

The Portuguese and Greek economies may face a “slow death” as they dedicate a higher proportion of wealth to paying off debt and investors demand a premium to hold their bonds, Moody’s Investors Service said. While the two countries can still avoid such a scenario, their window of opportunity ’’will not be open indefinitely,’’ Moody’s said in a report today from London. Portugal, with a negative outlook on its Aa2 rating, has more time “to reverse this trend” while Greece “has significantly less time.” Moody’s cut Greece’s rating to A2 from A1 on Dec. 22. Full Story

In our opinion they should be adding Spain, Italy and Ireland to the equation and we are sure several more members are going to be running into trouble soon.

Saving the euro from a Greek tragedy

EU finance ministers are pressing their indebted and riot-prone Balkan member to embrace a massive austerity plan and plug its debilitating deficit. But with markets skeptical and the appetite for more bailouts at a low, there are deepening concerns that a Greek meltdown could deal a severe blow to the very European idea of a common currency, and set off a domino effect through Italy, Spain, and Portugal. The EU's economy commissioner Joaquin Almunia warned of a domino effect, saying Greece's debt crisis is already hurting other indebted countries that use the euro as nervous bond markets hike borrowing costs on fears that Greece could default or demand an unprecedented bailout from reluctant EU states.

"The fate of one is the fate of all," he said. "This situation in Greece is having effects in other countries." Eurozone nations are trying desperately to patch up the cracks, promising Monday to do more to run their economies in a uniform way and accepting possible warnings when they go astray -- a major shift for sovereign nations that are not keen to see more EU oversight.

But Greece is the real litmus test.

If Greece can't deliver the cuts it is promising and risks not being able to repay its debt, it will likely seek a bailout from EU members to rescue it from a crisis of its own making, where failure to curb a bloated public sector and endemic corruption have dragged down economic growth. Finland's Finance Minister Jyrki Katainen bluntly said that would be asking too much. The Greeks couldn't expect "any outside help" and "it's purely up to them how well they will treat this crisis," he told reporters. Full story


When we take all these factors into consideration, there is a real possibility that something could go potentially wrong in the Euro zone. Greece is a ticking time bomb and not only is the government plagued with corruption, but unless they implement very severe and painful cuts, the problem is only going to get worse. A default here could trigger defaults in other weak members such as Ireland, Italy, Spain and Portugal.

The current pattern is projecting that the dollar will mount at least a 3 month rally if not longer that could lead to a new 52 week and possibly 2 year high. A strong rally in the dollar could have far reaching effects. It will certainly lead to a pretty severe correction in the commodities markets and most competing currencies will in turn experience strong pull backs, with the potential for some to completely break down.

If you have no position in the dollar wait for a pullback before opening positions in UUP and short positions in the EURO via EUO.


Disclaimer: we have positions in EUO and UUP.

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