T/A: Euro Bullish Divergence

December 20, 2005

Technical analysis has issued a loud positive signal for gold investors, and to currency traders. The euro currency is key to the USDollar in recent weeks in the Foreign Exchange markets (FOREX). The Japanese yen has been relegated to the background since the summertime, as a consequence to the Chinese yuan upgrade in July. That news stole the limelight and focus from Asian skirmishes. My last few articles have granted concentrated attention to currency matters and influential gold factors. My reasons are clear. As gold has decoupled from the USDollar, it has begun a strong climb in all major world currencys. However, as the USDollar resumes its long-term bear market decline, weakened decay, and deterioration, gold will skyrocket in the long awaited upcoming major Elliott Wave III. Analysis can show that the euro is ready to rebound strongly, which will hurt the dollar DX index. The effect will be a powerful favorable lift for gold.

The euro currency has displayed a technical chart signal which is often missed by the experts. In a discussion with a new buddy in Zurich (JohnM and wife Lidia), met in Munich at the first annual gold conference in November, the "bullish divergence" in the euro chart was noted. The essence of the signal is that lows are tested for the price, in a challenge of April and July lows, a slight breakdown occurred, BUT weekly closing prices perk up in a more healthy fashion than would be expected during a breakdown. A technical contradiction was issued, to counter the claimed breakdown. In fact, as measured by the weekly stochastix, closing prices actually improved their behavior compared to what had been observed over past lows. Thus the bullish nature of a stochastic divergence in weekly resolutions, in a non-confirmation of a worsening price situation. Translate, to herald an improvement in the price situation, from an obscure but reliable indicator amidst powerful forces.

Let's check the actual chart and its clear signal. Note the three-year chart with 20-week moving average and 50-week moving average. The above indicator window reveals the slow weekly stochastix. First, the rapid cycle has turned up to cross above the slower cycle, called a "stochastic crossover," bullish in its own right. Second, and more important to the topic of this article, notice how the lows of June & July saw worse price closures on a weekly basis than seen a short time ago in November. If the euro, with its break below 119 in November, had been on the verge of an aggravated decline, then the stochastix would have shown more frightening lower closes, and thus bad confirming signals. They did not, even as the so-called FOREX experts were trotted out on CNBC with incessant banter about a breakdown to 115, or worse, a retracement all the way back to 100. Perhaps FOREX has its own spin meisters to lure sheeple into stupid positions, so as to be fleeced by the experts. Methinks YES. A stable European Union economy and strong trade surplusese dictate a resumption in the euro rise. Lost interest rate differentials and horrendous USDollar fundamentals (trade gap and budget deficits) dictate a resumption in the clownbuck relapse. Before any traction can be found and felt, the euro must proceed and work its way through the 20wMA at the 120 level. Notice it has undergone a battle for a full week, with almost no volatility whatsoever at 119 to 120. That 20wMA will be flattening out in the next few weeks, sure to assist in the euro in pulling itself above the critical 119 mark. So the breakdown might have been a fake-out after all, as 119 remains critical long-term support.

So, what does this mean? In my analysis, it means the euro is about to resume its bull trend which was launched in 2002 in earnest. Look for a euro rise toward 129 as early as the summer months of 2006, at least by year end. Correspondingly, it means the USDollar is about to resume its bear trend which began at the same time. The dollar DX index is a poor excuse for an index. It has been a regular target of my critical words. It is trade-weighted, but from the 1960 decade when the European weight was four times the Japanese weight. The DX index has over 50% weight in the euro, less than 20% with the Japanese yen, and nothing at all for the Chinese yuan. My best answer to the questions "Why use it? Why not update it?" are that it has forward trading and strategies which cannot easily be changed. Furthermore, the low weights given to Asian currencys permit us guys to ignore them, and to regard them as in a permanent state of official shun, a hedonic relegation to sidelined status. The lower that the yen went in recent years, the cheaper the US imports became in price. Consider the Chinese yuan, formerly pegged to the US$, and now in a quasi-peg outside the realm of trader whimsical action. The yuan peg has been broken, but it does not yet trade in free-floating fashion. Some call the Chinese - American sphere the "dollar bloc" since our economies act as one, without currency shifts of essence.

The dollar DX is thus the most inaccurate, misrepresentative, least meaningful index among the high profile indexes. Some call the DX index the "anti-euro" index since its largest component is the euro currency. In a major Elliott Wave III phase, three things align in coordinated fashion, much like a perfect storm. One, the chart technicals and price movement look just right in one direction, a clear story depicted. Two, the fundamentals behind the movement become crystal clear. The experts line up in unison to proclaim the new phase in a consensus fashion, as they recite those fundamentals. Three, the public catches wind of the story, enough to propel the investment vehicles to new heights. We are fast approaching this EW3 phase. It is not here yet, but its day is nigh on the horizon. My suspicion is in the new 2006 year, hedge fund positions will unwind and lead to mining stock short covering, subsidiary repatriation of USDollars will end, and the new Bernanke USFed will be inaugurated to usher in a new hyper-inflation era. These events will mark major sea changes in the new year.

Look for the USDollar index to falter in coming months. Its pillars have eroded, one by one. Its fundamentals are far worse than dreadful. Yet so-called economic experts proclaim strength in the USEconomy in an absurd fashion, worthy of derision and laughter. The only detectable strong indicators in the USEconomy are high S&P500 stock prices and high housing prices. If the DX index falls much below the 90 level, look for hedge funds and program trades to kick in to send the DX downhill with significant speed and gusto. That will be the story during the Bernanke inauguration, as record trade gaps are announced to contradict claims of economic robustness and strength. The cognitive dissonance will be extremely loud and clear for all to hear and see.

The US Treasury yield curve has been flat for a couple months, a clear unmistakable warning signal. As in, the spread between the 2-yr TBill yield and the 10-yr TNote yield has been stuck in the 5 to 15 basis point range. A spread less than 0.15% is a very loud yet unheralded signal, considering how an inverted yield curve has been such a reliable market signal for economic recession over the past twenty years. The graphic below screams a 7 basis point difference for the Treasury 2-10 spread!!! The financial markets have shown a strong preference to declare "it is different this time" and deny critical turning points marred by losses. We saw it in 1999 with over-priced stocks, justified by technology advances, and telecom progress with cellular phones, fiber optic connections, broadband transmission speed, and the internet. Well, to be clear, the internet made profitability far MORE difficult, due to instant pricing information, despite the streamlined supply chains from orders to inventory to suppliers. The bond bubble is about to give off massive gas. The upshot will be lost opportunities to extract home equity, probably the biggest single source of money available to consumers. The USFed chairman and governors had better pay attention. This is a forced, mandated, controlled flattening of the yield curve imposed by a clueless central bank. They must believe the falsified statistics themselves, since in doing so, they pat themselves on the back for a robust economic performance. Chairman Greenspasm is on record denying the significance of the flattened or inverted yield curve. Recall he misread productivity in 1999, and denied technology stock over-valuation. This man has a track record, one fully forgotten at every critical turn in the road, or during every sea change.

The loud signal from the flat yield curve is telling the international community that the USEconomy is in the midst of a slowdown.Sure, some clueless observers might accept the falsified US GDP data, announced at a +4.3% growth rate in 3Q2005. They might believe that rising prices can be construed incorrectly as claimed economic growth. They might believe that sales of higher speed technology items should be multiplied by 10 to 14, so as to lift the GDP figures to lofty levels. They might believe that the GDP Deflator should be an order of magnitude lower than the widely scorned CPI series, thus permitting inflating prices to lift the GDP higher than reality. They might regard chain weighting as a wise practice, a technique used to amplify and compound erroneous effects. Heck, if a method lifts the GDP, then great!!! No way, José! Credit the international markets as having a healthy dose of distrust for all statistics American. My new German and Swiss colleagues have a complete distrust in US official statistics, and disturbing questions about the sanity of our leaders, especially financial. With a slowing USEconomy, the USDollar is ripe for a resumed decline.

Let's not overlook a well recognized phenomenon, one which seemingly has been forgotten. After a time lag, 13 USFed rate hikes have an accumulative effect on the USEconomy, to slow it down. Borrowing costs are up. Debt service is 12.5% of disposable income. Mortgage rates are up for adjustable contracts by more than a full 1% in the last year. Vendor financed deals are not exactly fading away but are costing more. Bond speculation off that flat yield curve described above has reduced easy profits from floating into the financial centers. Hedge fund profits are not overflowing. Bear in mind that in response to the last USFed rate hike decision on Dec 13th, the long bond (10-yr TNote) actually declined in its yield, so far by 10 basis points. It is telling the market that the rate hikes have gone too far. In official parlance, the bond reaction to the USFed rate hike is an insult and an order to halt, an urgent admonishment.

The struggling crude oil price is the second warning signal. My particular slant on observing the crude oil price differs from most. The winter weather is here, just like in the last thousand years, maybe more. Don't credit Americans for cutting back on driving too much, in response to higher gasoline prices. Those higher gasoline prices at the pump are gone, back to pre-hurricane levels. Crude oil consumption is down because the USEconomy has begun its slowdown. China is also slowing in its crude oil consumption. Europe is probably lower in its usage as well, whose gasoline prices have gone from very high to extremely high.

The crude oil price struggles to stay over $60 per barrel. TBoone Pickens expects crude oil (erl, as they say in Texas) to test the $50-54 level in the first half of 2006. However, in the second half, he expects the $70 mark to be breached. The energy prices, in particular oil and distillates like unleaded gasoline and diesel fuel, are telling the market of reduced economic activity, reduced industrial activity (like at General Motors and Ford). The Chicago PMI (Purchase Manager Index) for November fell from 62.9 to 61.7 on its index. The ISM (Institute for Supply Mgmt) for November fell from 59.1 to 58.1 on its index. Car sales in November were disastrous, -15% for GM, -15% for Ford, -5% for Chrysler, +10% for Toyota. Such are the diverse real economy signals telling of slowdown, with some confirmation.

The strange twist with the USDollar relationship calls for the US$ to experience some support as the crude oil price softens. This is the time honored petro-dollar effect, which calls for the two entities to move in opposite price direction. A weaker USDollar in future months portends a higher oil price, independent of physical demand. Foreign oil producers sell oil in USDollar terms, so they raise their prices as the US$ exchange rate falters. That is the commercial side of the equation forces. As crude oil rises in price, cash reserves held in USTBonds in foreign locations are sold in order to make the higher payments. That is the financial sector side of the equation forces.


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Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a PhD in Statistics. His career has stretched over 24 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com. For personal questions about subscriptions, contact him at [email protected]

Jim Willie

Jim Willie

Jim Willie CB, also known as the “Golden Jackass”, is an insightful and forward-thinking writer and analyst of today's events, the economy and markets. In 2004 he launched the popular website http://www.goldenjackass.com that offers his articles of original “out of the box” thinking as well as content from top analysts and authors. He also has a popular and affordable subscription-based newsletter service, The Hat Trick Letter, which you can learn more about here.  

Jim Willie Background

Jim Willie has experience in three fields of statistical practice during 23 industry years after earning a Statistics PhD at Carnegie Mellon University. The career began at Digital Equipment Corp in Metro Boston, where two positions involved quality control procedures used worldwide and marketing research for the computer industry. An engineering spec was authored, and my group worked through a transition with UNIX. The next post was at Staples HQ in Metro Boston, where work focused on forecasting and sales analysis for their retail business amidst tremendous growth.

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China is the world’s biggest gold producer with more than 355 tons annually. Australia is second.

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