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June 10, 2005

Dollar Target Right On Track
by Jes Black

In our last public posting titled "Dollar Seasonal Trends Dominate Market" we stated that the dollar's selloff in March was "simply a test of the lows before the greenback rallies above its January highs." Below we show the chart of dollar seasonality where we correctly forecasted a move to 88 in the dollar index before a near term pullback then final rally to 92 by August 2005 where we plan to take profits.

As is now clear, the "No" votes in Europe helped sink the euro, but more importantly this offers a strong supporting argument to why we believe the next big move for the stock market is DOWN.

Consider that the process of integration began in 1946 after World War II when a number of European leaders became convinced that the only way to secure a lasting peace between their countries was to unite them economically and politically. This process began when the stock market adjusted for inflation was at a nadir. It then carried upward and onward on the back of a worldwide Bull Market. In 1957, the Treaty of Rome established the European Economic Community. Then, in 1967, at the Zenith of the inflation adjusted Dow, the institutions of the three European communities were finally merged. From this point on, there was a single Commission and a single Council of Ministers as well as the European Parliament.

Little progress was made during the 1970's Bear Market, but as the market began to recover the first direct elections were held in 1979 and the barriers to travel were greatly reduced during the 1980s until the Single Market was formally completed at the end of 1992 and citizens could travel freely. In 1999, as global stock markets reached a momentous peak the euro was introduced.

The fact that two of the original six countries that have strived for more unification over the past six decades would vote "No" signifies a major reversal in sentiment from unification to the breakdown of the confederacy. Mind you, the US Civil War was ignited after a 30-year bear market convinced the Southern States that they would be more prosperous on their own. In similar fashion, the breakdown of deficit targets and now possibly the euro shows how Bear Markets tear down the icons of Bull Markets and slow economic progress to a grinding halt.

The following commentary is from our weekly report on June 6, 2005:

Stock Focus: For weeks now we have said this countertrend rally would top around the 1200 mark. As the market chopped higher we showed you that Fibonacci time relationships called for a major peak last week, which we said offered an excellent opportunity to position short if you had not already done so. Below we have updated the same Elliott Wave count and the Fibonacci time series we have been talking about.

In the top chart note that a Fibonacci 21-calendar day turn cycle has been in effect. Moreover, this lined up perfectly with the March turn cycle which has marked 4 major tops and 2 major bottoms over the past six years - none of which have were challenged. Note that the confluence of price and time targets resulted in a bearish weekly reversal (orange box) as the market rallied to the underside of broken trendline support. We recommend adding to shorts on a break below trendline support (blue line top chart) next week - risk above March highs.

Bond Focus: Our bond short was stopped out for a wash, but we remain even more convinced that bonds have topped. A variety of sentiment measures that we follow reached highs above 90% bullish last seen at the February highs when we also made a strong call for a bond market top.

In the following chart we show how two separate cycle turn dates converge this month. Note that each orange bar represents a 9-month cycle turn whereas the blue lines on the top chart represent a 12-month high-low-high cycle turn date connecting the 2003 high, 2004 low and this month's 2005 highs.

The reason we feel that this cycle turn date will end up being fairly significant is that two important bond market mavens have turned from bearish to bullish on bonds (Gross and Roach) which we view as a capitulation by the last bastions of bond market vigilantes right when the technicals say sell.

Note that the five-year note has rallied right into key resistance at 110 just as two cycle turn windows converge. Moreover, real yields (yields adjusted for inflation) as determined by yields divided by the price of gold, just reached a new all time low. Also note that major bond market tops in our cycle turn windows coincided with major lows in the yield/gold ratio (as shown with the blue lines connecting the top and bottom charts).

In the price action is imbedded intelligence and the sharp bearish daily reversal after a clear "five wave" pattern higher from the March lows suggest we should see at least a multi-week pullback in bonds. But for a move to 111 to occur, key resistance turned support at 113 will have to first be broken.

A multi-week rising rate scenario would also lend a hand to our view that stock prices are about to head sharply lower. In addition, rising rates would aid the dollar's newfound friends in the analyst community that are now talking about interest rates and not the deficit. Isn't it fun watching them come out of the woodwork like the 'knew' it all along.

As such, we expect a dollar peak to occur right as the stock market decline convinces the market that the Fed has finished its "ninth inning" of rate hikes. This is why we follow an integrated approach of stocks, bonds, currencies and commodities to make a "holistic" forecast on the overall market trends.

Currency Focus: Our biggest mistake this past week has been trying to call a top to a "wave III" rally. Yet our two hedges have not hurt us in the least. Recall that we purchased EUR/USD at 1.2513 and moved our stops up to here on the rally to 1.2585 before the French referendum vote. We were obviously stopped out, but put on a hedge in GBP/USD at 1.8210 and then again at 1.8110 after getting stopped out of that. Sterling ended the week at 1.8145 and we remain long USD/CHF from 1.1830 and short AUD/USD from 0.7750, which we plan to hold until we cover our entire dollar long position as these two pairs represent our "core."

Below we show an update of our wave count that has been in effect since February. As we showed you last week, the euro was sitting right on key support at 1.25, which marked both channel support and the Fibonacci 61.8% retracement. We thought this would lead to a bounce back to the key 1.2750 level before a renewed selloff. But the French and Dutch "No" votes led to a sharp 400 pip decline as the vote served as a catalyst to shake out the last euro bulls.

Note that we have either finished "wave 3 of C" or will do so in the coming days with a "wave 4" bounce to give way to the final selloff in "wave 5" where we will look to close out our dollar longs. With the 1.25 support level now serving as resistance we would use any bounce back towards this level as an ideal opportunity to add to your shorts.

The most troubling aspect of this dollar rally is that precious metals have not fallen below their February lows. It has also been interesting to note the recent surge in copper and silver, while aluminum remains beaten down. So we are not inclined to back off our bearish view on gold unless the euro price of gold were to surge above €350 per ounce. Note that next week marks the 6-year high-low-high turn cycle in gold priced in euros. If €350 can hold we expect a protracted decline in gold. If it breaks it would indicate that the markets were shunning paper money in favor of hard currencies and we would turn bullish on gold. Key resistance is at $438 in gold and $8 in silver.

Getting back to our FX forecast, below we update for you the same chart from last week identifying where we felt the dollar rally would terminate. Note that our "zig zag" formation represents our expectation for a "wave IV" consolidation move in the near future before a final decline to 1.17 in the euro.

This level has a high degree of technical significance and the fact that the euro's selloff gathered a lot of bearish momentum from the "No" votes, we think that a move to 1.17 will likely mark a crescendo of bearishness necessary to mark the lows.

As such, we are still expecting a pullback in the dollar in "wave IV" next week but only looking to short it as a hedge to 1/3 of our dollar long position. Traders looking to initiate positions should buy the dollar dips with risk limited to just below the 85.25 mark, as only a move though here would invalidate our current Elliott Wave count.

Finally, for fun we update our S&P 500 to Dollar Index bottoming-formation relationship that we first showed you back in March and last updated in the May 8 weekly edition.

Below we show you the same series of charts from the May 8 edition. Note that we then made a strong call for a rally through 85.25 to target 92 over the coming months. In the middle chart we have updated the dollar's progress to date. Finally recall that the bottom chart is of the S&P 500, which we are using as a guide for what to expect when a major market breaks a three-year downtrend line.

Recent Testimonial for FX Money Trends: "I find FX Money Trends' work extremely helpful. As a macro hedge fund manager I base my success on ideas generated both internally and through external research services: FX Money Trends and its founder Jes Black constantly provide ideas which are based both on very clever fundamental and technical analysis and research. FX Money Trend's intellectual independence makes their ideas precious, never obvious nor "late." - Francesco Clarelli, Italy.

Jes Black
fx Money Trends

Jes Black, hedge fund manager at Black Flag Capital Partners, specializes in foreign exchange and global macro trends. Prior to organizing the fund he helped MG Financial Group launch Forexnews.com. In the summer of 2004 Mr. Black formed FX Money Trends, a research firm catering to professional traders.

Mr. Black holds a degree in economics from the University of Kansas and an MBA from the ESC in France. His market commentary is often featured in the Wall Street Journal, Financial Times and Reuters. He has also written numerous strategy pieces for Futures magazine. To find out more about the funds research letter visit www.fxmoneytrends.com/products.html. Qualified prospective investors can find out more about Black Flag Capital Partners by e-mailing info@blackflagfund.com

Under no circumstances does the information contained in this site represent a recommendation to buy, sell or hold any security.

Copyright © 2004-2007 Jes Black

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