A Currency Market Reversal Could Change the Landscape for Stocks and Commodities

Investors and traders often get caught up in the latest news cycle while ignoring one of the most significant price drivers; the currency markets. For whatever reason, changes in currency valuations are always part of the after the fact discussion to explain changes in stock and commodity valuations but, in my opinion, monitoring the currency market should be a part of a habitually proactive analysis scheme. In other words, those looking to speculate in stocks or on commodities such as oil, natural gas, gold, corn, or the likes, should first consider the value of the U.S. dollar and other major players in the global currency market. This is because, by nature, prices are tied to currency values. Why do currencies matter to stock and commodity traders? Even those who have no intention of trading FOREX should be aware of changes in the currency markets. The only way to purchase goods and services, or even stocks and commodities, is to give up something else; usually a currency. Accordingly, as the value of that currency fluctuates so will the motivations of those executing the transaction. In the simplest scenario, a higher dollar will put pressure on commodity prices because it makes U.S. exports less attractive to global buyers. Conversely, a lower dollar typically supports commodity prices because it makes U.S. goods seem less expensive to overseas buyers. This concept also filters into stock market valuation; it is generally true that a stronger dollar can hamper corporate profits and vice versa. With that said, these expected correlations are not always evident; thus far in 2018 some of the historical intermarket relationships have strayed from their norm as investors have attempted to brace themselves for abnormal market pressures such as the trade war. Nevertheless, we tend to believe the relationships will soon normalize. If so, and our expectations of a lower dollar (higher euro) going into year's end should eventually support most asset classes. The masses are already short the euro We always make a point of being aware of what other traders are thinking; more importantly, where they are placing their wagers. Our friends at Consensus Bullish Index suggested that a mere 26% of industry insiders polled are bullish in the euro against the U.S. dollar (likewise, a significant majority are bullish the greenback). This is an extremely pessimistic level in regard to the euro, which is generally a sign of exhausted sentiment. Thus, we believe the euro will soon begin to recover and the U.S. dollar will succumb to gravitational pull. Not only is the sentiment in the euro at an extreme bearish level, but traders are putting their money where their mouths are. In the euro futures market, speculators are holding the largest net short position seen in the previous 16 months. With that in mind, if you scroll back the data further you will find situations in which speculators were far more bearish (short) the euro, but given the improving fundamental landscape (Italian bank concerns dissipate), positive seasonal tendencies and chart support, we believe the shorts will be inclined to cover positions (buy) and bullish traders could be lured into the excitement. The big picture in the DX To corroborate our ideas in the euro, we wanted to look at the inverse product (or at least the best form of it available). The U.S. dollar index listed on the ICE futures exchange is based on a basket of currencies but the euro makes up over 60% of the holdings. It has traded comfortably above $94.00 for weeks and appears to have room to move higher in the short-run. Technical oscillators on a weekly chart aren't necessarily suggesting an overheated rally; the RSI (Relative Strength Index) is in the low 60s. Further, trendline resistance won't come into play until prices reach $97.50 to $98.00. Yet, standard technical analysis methods are pointing toward the dollar index finding sharp resistance and potentially reversing its course at, or near, the noted levels. This is in line with our bullish expectations of the euro. Chart Source: QST The euro could be setting up for a year-end rally Both the daily and weekly euro charts suggest the downside is likely limited from here. That doesn't mean we expect prices to turn on a dime; in fact, we think the EU currency could experience continued weakness in the short-run. Nevertheless, the longer-term prospects for the currency appear to be positive. The daily euro chart, specifically, depicts a potential double bottom in which support looms near $1.1400 and then again around $1.1300 to $1.1250ish (trendline support). An RSI dipping below 70 supports the premise of an oversold market and should increase the odds of a short covering rally. Chart Source: QST The weekly chart of the euro currency offers a similar area of support near $1.1250 as marked by both the downtrend line dating back to last summer and the uptrend line dating back to late 2017. Technical oscillators, however, on a weekly chart basis are not yet in oversold territory. This leads us to believe a test of the $1.1300/$1.1250 area will likely be seen before the trend reverses course. Chart Source: QST Conclusion Whether you are trading stocks or currencies, it is a good idea to keep tabs on the currency markets. It often provides clues into price tendencies of other assets. Additionally, the financial markets have grown comfortable with the existing low-volatility currency trends, but there are signs pointing toward a change in theme as we head deeper into the fourth quarter. *THERE IS A SUBSTANTIAL RISK OF FINANCIAL LOSS IN TRADING FUTURES AND OPTIONS.

A Currency Market Reversal Could Change the Landscape for Stocks and Commodities

Monitoring the currency market should be a part of a habitually proactive analysis scheme.

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