Markets

Gold on Verge of Major Decline; Commodity Currencies Warn of Trend Shift

FUNDYS

The US Dollar has been well bid over the past several weeks and we are now nearing the point at which we will soon find out if the rally in the Greenback has been more of a corrective rally within a broader USD downtrend, or if the Buck is attempting to mount a significant longer-term across the board appreciation. Despite the lightened holiday trade, markets have been quite busy over the past several hours with a number of key developments influencing price action and weighing on sentiment. These developments would certainly support the argument for more significant USD gains over the medium-term.

Relative Performance Versus USD Friday (As of 9:05GMT)

  1. SWISSIE-0.15%
  2. STERLING -0.35%
  3. YEN-0.37%
  4. CAD-0.52%
  5. KIWI-0.54%
  6. EURO-0.82%
  7. AUSSIE-1.26%

Pressures in the Eurozone have been mounting and the threat and fear of contagion is still very much alive with many now focusing on today's Irish Donegal by-election which could compromise the passing of the Irish bailout. Additionally, we have been seeing some more negative press out of the peripherals, with a Bloomberg article warning that foreclosed homes in Spain may triple next year as new accounting rules force local banks to rid themselves of depreciating assets more quickly. To add more fuel to the fire, geopolitical risks have also not faded with North Korea on the wires saying that the US and South Korea are inching North Korea to the brink of war. All of these developments have helped to extend broad based USD gains in recent trade, with the risk negative sentiment benefiting the safe haven Greenback. We had seen some short-lived attempts at currency buying following some hawkish talk from ECB Liikanen, while model funds also helped to inject some bids in the Euro as it tested major trend-line support by 1.3250, but given the intensity of recent moves, the efforts proved to be fleeting.

While the lower yielding safe haven US Dollar finds bids on the back of the risk liquidation, the highest yielding major currency has come under intense pressure on Friday with some local developments helping to fuel additional relative weakness in the Australian Dollar. RBA Governor Stevens has caught the markets off guard after sounding surprisingly dovish in front of a Parliamentary economic committee earlier today. Stevens has said that rate setting is now \"appropriate\" and with global growth expected to moderate next year, he anticipates a decline in key resource prices. The central bank governor went as far to even say that current policy was a little tighter than average and that rates would not be moving for \"quite some time.\" This is a significant departure from the hawkish rhetoric that we usually hear from the central bank governor and should be taken as a clear sign that the threat of a slowdown in the Australian economy is becoming very real.

We have been warning of this for some time now and are pleased to see that the central bank is starting to acknowledge the same red flags that we are. Additionally, recent steps by China to tighten policy and curb growth should be influencing the more dovish outlook from Stevens who is very aware of just how much of an impact a cooling off in China will have on the local economy. The Australian Dollar has served as a proxy for the risk trade and any appreciation in the currency has been reflective of a risk positive sentiment in the markets. Surely, a beleaguered Eurozone economy, rising geopolitical threats, and a cooling off in China should then weigh quite heavily on the Australian Dollar going forward, especially now that the prospect for additional rate rises have diminished.

This exposes the Australian Dollar to some major weakness over the medium and longer-term and we would also contend, by extension of this fact, that the anticipated weakness in the antipodean currency might act as a leading indicator for some future weakness in commodity prices, with a specific reference to gold. We contend that the yellow metal has put in a meaningful high and is currently in the process of carving out a major top. Technically, we have been anticipating such a shift in the market and would present three charts which we believe make the argument for a pullback in gold prices all the more compelling. Clearly the foundation of this argument is also based on the assumption that currency markets are a leading indicator for all other asset classes.

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The Aud/Cad cross which is a pure commodity cross currency has been the first to roll over and confirm the formation of a major head & shoulders topping pattern. It would make sense that this cross would be the first to trigger such a pattern as it would be the most sensitive to shifts in the outlook for commodities given that it is a pure play commodity cross. We would liken the cross to a shorter-term moving average that is warning the markets of a potential shift in the broader trend. In the chart above we can clearly see the trigger of the major topping formation in Aud/Cad.

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The second chart we present is what we would liken to a more medium-term moving average. This chart is the Aud/Usd chart (above) which also shows the formation of a major head & shoulders top. However, in this case, the formation is only just now testing the neckline and has yet to trigger. But based on our argument that the pure play Aud/Cad commodity cross is a leading indicator, we would then expect to see this H&S topping formation soon trigger to open the door for a major drop here as well.

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Finally, we take a look at what we would liken to the longer-term moving average and the critical indicator to officially confirm a major shift in the trend. This is the actual commodity itself. A closer look at the gold chart (above) shows the same formation of a head & shoulders top, only at an even earlier stage in its development, with the market only just now carving the right shoulder. But if we are to use the Aud/Cad and Aud/Usd charts as evidence, the argument for an eventual trigger of a major top in gold prices becomes very compelling.

This is significant, as a shift in the outlook for gold could have a material influence in the direction and sentiment in the broader global macro markets. Gold has been one of the most, if not the most reliable asset classes over the past several years, with the commodity managing to find demand both in risk positive (growth and demand for commodities) and risk negative environments (hedge against inflation). As such, a shift in the overall trend in the commodity could open the door for a major shift in the construct and dynamic of the broader markets. If global growth prospects diminish and there is no longer demand for the commodity on that front, and if market participants no longer see demand for the metal as a hedge against inflation, then we could see a more significant rally in another market....that being the US Dollar.

It will certainly be interesting to see how this plays out, but technical studies are definitely warning of a major fundamental change. As far as the Greenback is concerned, we are in the camp that holds a longer-term bullish outlook for the US Dollar irrespective of current Fed policy and structural deficiencies in the US economy. After all, in currencies, it is all about relativity. You don't have to be perfect to stand at the top.....you simply have to be better than all the rest.

GRAPHIC REWIND

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TECHS

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EUR/USD: We have finally reached a critical inflection point, with the market now testing some major rising trend-line support off of the 2010 lows, which comes in by 1.3250. A sustained break below 1.3250 over the coming days will suggest that the market has broken a major uptrend and is on the verge of a material shift in the structure favoring additional USD gains, while inability to establish below 1.3250 will keep the bullish trend intact. Daily studies certainly show room for additional declines from here, so we would not at all be surprised to see a sustained break below the trend-line. Next key support comes in by the 200-Day SMA at 1.3130, with the 50% fib retrace off of the 2010 low-high move just below at 1.3085. Look for any inter-day rallies to be well capped around 1.3500, with only a break back above 1.3635 to really give reason for concern.

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USD/JPY: Although the market is locked in a broader downtrend, there are definitely clear signs emerging that we could finally be on the verge of a major shift in the structure. The price has not managed a close above the daily Ichimoku cloud since May, and the latest break back above the cloud suggests that we are in fact in the process of undergoing a shift in the trend. However, the market is only just now breaking above the cloud, and with the 100-Day SMA (84.10) still capping gains, we would recommend waiting for a clearer and sustained break above these 2 indicators for official bullish confirmation. On the other hand, the bottom of the cloud currently comes in by the 82.00 figure and a close back below here would be required to signal bearish resumption. As such, we are now in a wait and see period and will stand aside to let things play out. It is worth noting that longer-term studies are quite stretched with the market by cyclical lows, and as such, our core bias and outlook for the pair is constructive.

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GBP/USD: A rising trend-line off of the yearly lows has now been convincingly broken to the downside, and the risks from here are for deeper setbacks towards 1.5300 over the coming days. Initial support comes in by 1.5650 and a break and close below this level should help to confirm bearish bias and accelerate declines. Ultimately, only back above 1.6300 would compromise medium-term structure and give reason for concern. Look for inter-day rallies to be well capped ahead of 1.6000.

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USD/CHF: We contend that the market is in the process of carving a material base by 0.9460, and any setbacks should be very well supported in favor of a sustained recovery. A fresh higher low has now been confirmed by 0.9550 following the latest break back above 0.9975, and the market should now accelerate beyond parity towards our next key topside objective in the 1.0280-1.0500 area over the coming sessions. The 1,0280 resistance represents the highs from September, while 1.0500 is the 200-Day SMA. Any intraday setbacks are expected to be well supported ahead of 0.9700.

FLOWS

Some model funds on the bid in Eur/Usd by 1.3250 trend-line support; other looking to sell clear break below; Middle Eastern and French names also on the bid; Offers now seen into the 1.3350-1.3400 area. UK clearer on the bid in Eur/Aud; Korean names buying Aud/Usd on dips. Offers in Usd/Jpy above 84.00. Leveraged accounts selling Aussie, Kiwi and Cad. Major US based currency fund buying USDs across the board.

Written by Joel Kruger, Technical Currency Strategist for DailyFX.com

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Other Topics

Commodities