by Kevin Klombies, Senior Analyst, TradingEducation.com, LLC


Monday, July 7, 2008

Chart Presentation: The Dollar

July 3 (Bloomberg) — The euro fell the most against the dollar in more than two months after European Central Bank President Jean-Claude Trichet signaled that he may not increase interest rates again.

Our view was that the euro would reach a decision point and then reverse to the down side. The initial reaction by the euro last week following the ECB’s rate hike may not have confirmed that we were correct but it did show that our view was at least not in error for the time being.

Below we have included a comparative chart of the U.S. Dollar Index (DXY) and the Baltic Freight (Dry) Index.

In past issues we have shown that major peaks for ocean freight rates have tended to go with equally major bottoms for the dollar with the last similar event taking place in 1995. The argument has been that the dollar would work through its cycle bottom as the BFI made its final peak. The chart suggests the potential for a shift back towards a rising dollar beginning back in May and June.

Below we have included a comparison between biotech company Amgen (AMGN) and the U.S. Dollar Index (DXY) futures.

On many occasions we have shown AMGN along with the dollar or AMGN relative to something like gasoline futures. The argument was that AMGN has been trending inversely to the energy trend and with the basic trend for the dollar.

The point is that the dollar has been in a negative trend for almost exactly 7 years with the closing peak registered on July 5th of 2001. In the mean time the CRB Index has risen by more than 2 1/2 times. To get to a bottom for the dollar we needed to see some sort of peak in ocean freight rates and a bottom for stocks such as AMGN. The charts on this page make a somewhat tentative case that a trend back towards a sustainably stronger dollar has already begun although quite clearly the DXY will have to rise well above its moving average lines to mark the turn. There are encouraging signs for the dollar which suggest downward pressure on the commodity theme but it is still much too early to mark this one as paid.

The chart below compares 3-month euribor futures with the ratio between Japanese bank Mitsubishi UFJ (MTU) and the gold etf.

According to Bloomberg Japanese banks recorded $13.5 billion in write downs associated with the recent credit markets crisis compared to $380 billion for European and U.S. banks. The negative trend for MTU began back in late 2005 as European short-term debt prices declined so a reversal of the trend back in favor of Japan’s banks and away from gold would likely go with the return to falling short-term European interest rates.

On page 4 we have included a comparative chart of MTU and Japan’s second largest bank Mizuho (MFG) along with the U.S. Dollar Index. Aside from the broader health care theme represented on page 1 by Amgen the trend for the shares of Japan’s banks tend to go very closely with the U.S. dollar. In other words the end of rising European interest rates and a stronger U.S. dollar would be a negative for the commodity theme and a positive for biotech, health care, and those financials not overly damaged by the subprime fiasco.

Below we show a chart of the CRB Index from 2000 to the present day and a chart of the S&P 500 Index from late 2001 to the present day.

We are comparing the trend for commodities with the trend for U.S. equities while suggesting that commodities have actually been leading the equity markets by roughly 12 to 15 months. In other words we have lined up the bottom for the CRB Index in late 2001 and early 2002 with the cycle lows for the SPX in early 2003. This also lines up the peak for the CRB Index through the first half of 2006 with the subsequent top for the SPX in the third quarter of 2007.

The point? If the relationship holds the equity markets should remain under pressure- likely due to commodity price weakness- into the seasonally weak October/November time frame and then drive to new all times highs through into the summer of 2009.

Kevin Klombies is a prolific writer and market analyst specializing in the commodity stock market and bond commodity market trading in the energy sector. He  graduated in 1980 from the University of Saskatchewan with a Bachelor of Commerce degree (Honours) in Finance/Economics.  Click here for full bio >>