Today, we got the ECB meeting and the Chinese trade metrics – both of which were bullish catalysts for commodities. The effects of both announcements today were effective in bidding up the euro and supplying the market with U.S. dollars. Some of the other risk-on currencies were also helped by the currency action today, but to a lesser extent. The chart on the euro has developed into a late-stage bottom. Upon breaking out, the implications on the dollar and commodities would be rather bullish. Such a signal could finally confirm a new long-term downtrend in the dollar. Such a condition in the market is a far cry from the predicted collapse of the euro so many had predicted in 2012.
Today’s News
I won’t belabor the fact that the Chinese economy is in full recovery mode – something I’ve expressed in full detail over the past few months. But today was another valuable data point in the story. Trade data released overnight showed that exports for December beat the street’s expectations by a very wide margin. Exports were up 14.1% versus the street expectation for a 5% rise. Imports were up 6% versus the street expectation of a 3.5% rise. The Shanghai rally wasn’t very impressed with the numbers, because the story has already been well-constructed now that their economy is improving. Both numbers were well above November’s data, so the question of near-term sustainability arises. Regardless, the fact that economic data that beats expectations is a bullish sign and has only been taking place in the last few months after China has suffered seven consecutive quarters of slowing growth.
Import data is what we want to focus on if you invest in China’s economy through the back door – commodities. Commodities are needed to manufacture and build out their infrastructure. So, instead of investing in a Chinese company that’s vulnerable to accounting discrepancies versus GAAP standards, investing in commodities is a back-door play on the Chinese economy. China equals demand; and, Brazil, Australia, the U.S. (coal/food), and Canada equal supply in the only financial equation you need to know. Today’s import trade data suggested that iron ore looks strong versus copper demand that has slumped. This confirms the story I’ve been telling on iron prices – which have risen 60% in the last few months.
The chart below shows how the Chinese import index has stalled over the past two years, but that looks to be changing.
Source: Bloomberg
The other news that hit today was the ECB’s January announcement. The voting members unanimously decided to leave rates alone. There was growing anticipation last week that the ECB would lower rates one quarter-point based on some members pushing for a cut in December and weak economic conditions. The non-standard measures were left alone, including the Open Market Transmission (OMT) which allows them to step into the bond markets to buy sovereigns of any country that has officially requested help from the bailout facilities (EFSF/ESM). Since the Long-Term Refinancing Operation was enacted in December 2011, the sovereign bond crisis has abated. This week’s Spanish 10-year auction was robust with yields breaking below 5% following the event this morning. So, the non-standard operations will remain, but the probability of lower ECB rates in the near future just dropped – a boon for the euro.
The euro has been strengthening ever since Mario Draghi’s bumblebee speech in July of 2012. He believed there was too much speculation in the market of a breakup in the euro and of sovereign bonds being repriced back in their former national currencies. Draghi came to the euro’s defense, not only in words, but in action. The current chart pattern on the euro is very bullish and depicts the final stage of a bottoming formation.
News Meets Analysis
With 57.6% of the dollar’s weight in the euro, a falling dollar is highly correlated to a rising euro. To take the relationship a step further, a falling U.S. dollar is highly correlated with rising commodity prices. As the euro bottomed in July last year, so too did the CRB commodity index; however, unlike the euro, the CRB index has been lagging as of late, and still needs time to develop before we can confirm a bullish long-term trend. Based on past experience, a bottom in the euro should be viewed as a bullish catalyst on commodity prices.
I’m bullish on commodities in general due to QE, China’s economic recovery, and the ECB’s defense of the euro, but I’ll focus here specifically on gold and oil and how their charts are developing. After mentioning in September that gold was near a significant supply zone at 00, and exhibiting overbought conditions that had previously caused investors to abandon ship, gold’s larger pattern shows a very long consolidation period in development. It, too, is nearing the final stage of a bottom, in my opinion, but it still needs to test two resistance zones before we test 00 again.
The first was a gap caused by the FOMC minutes last week at 1674. We closed today at 1678 in the U.S. futures market, which effectively closed that gap. The next resistance zone gold will face is 00, which was the former support level in November, and is the 50-day moving average on the continuous futures contract. A break above 00 would indicate that a double-bottom has formed for gold, representing an intermediate-term reversal for the metal. Bullish divergence in momentum (looking at the RSI over the past month) is a warning that there is a high probability of such a reversal taking place, especially when gold failed to reach a lower low on the FOMC catalyst last week; rather, it bounced off of former resistance, now a support level near 25 intraday Friday last week.
Looking at oil, the chart pattern over the last two years is slightly different, but a consolidation is occurring, just as it is for gold. There is a trading channel on oil with support near $78 and a resistance zone near $110-$116. We’re currently testing the declining trend established in 2012. A break would suggest $100 is the next test area, but ultimately a test of the $110-$116 area.
Conclusion
Do we recall in 2010 that the Federal Reserve Bank initiated the second QE program, at a time that most other Central Banks were carrying out restrictive programs, raising rates to stem a rise in inflation? That was the ultimate setup for a drop in the U.S. dollar. We don’t quite have that situation right now with virtually all of the major world banks holding policy at extremely accommodative levels, but a pause by some is an inflection point, while others continue to step on the gas, like Japan and the U.S. That spells a bearish situation for the currencies of Japan and the U.S., and a bullish one for China and Europe, as their economies improve.
