The Euro/Dollar Dance

By: Sol Palha | Fri, Jan 22, 2010
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"Imagination is more important than knowledge. For knowledge is limited to all we now know and understand, while imagination embraces the entire world, and all there ever will be to know and understand." ~ Albert Einstein, 1879-1955, German-born American Physicist

In the last two weeks of December we made the following comments

In the short to intermediate time frames, we would like to point to several new factors, which suggest that Gold could potentially pull back more, the dollar could mount a stronger than expected rally which should lead to a rather strong pull back in the Euro and other competing currencies. Certainly, the dollars rapid move from 74.57 to a high of 78.50 has caught a lot of traders with their trousers down. Full Article

And on the 16th of December we made the following comments

In the short to intermediate time frames the dollar is projected to mount a rally; it has already mounted a rather decent rally from its lows. Gold and most competing currencies are expected to pull back. We mentioned this in our recent article "The Gold bull; time for a breather or?". Since then Gold has already shed 100 bucks and the Euro has dropped from a high of 151.37 to 145.33 in a few days, a huge move for any currency. The sentiment against the dollar is extremely negative and has hit an extreme note; extreme movements always produce countermoves that are equally extreme if not stronger. Thus the dollar could potentially mount a very strong rally surprising even the most bullish of optimists. Full Article

In fact in December alone we published 3 articles on Gold, the Euro and the dollar a rare anomaly as we normally do not publish more than one article per month on a given topic. Since then the Euro has pulled back tremendously; from low to high it has shed over 7%. This is a huge move when one considers that it has taken place in less than 30 days. The dollar from low to high has tacked on over 6% and Gold has shed roughly 137 dollars.

So where do we stand now?

The dollar is very close to hitting a critical point; it needs to close above 78.50 on a weekly basis. A weekly close above 78.50 will be the first sign that the dollar is getting ready to potentially mount a much stronger rally. We stated in previous articles and repeatedly warned our subscribers that a stronger dollar would eventually affect the equity markets. Initially, the Markets ignored the strength in the dollar and traded higher in tandem with it, but now the tide has turned and the action of the last 3 days, indicates that the markets are long overdue a correction.

The Euro demonstrated further weakness by being unable to re test the 146 ranges; instead after trading as high as 145, it reversed course and traded as low as 140 before stablising.

A monthly close over 81 and a weekly buy signal from our indicators (weekly buy signals are based on 4-6 years worth of data, with each bar representing one week's worth of data) would be one of the strongest signals, we could get in terms of the dollar mounting a stronger than expected rally.

On the same token a weekly sell signal with a monthly close below 140 for the Euro would be a very strong indication that the Euro could trade down to the 130 ranges and possibly spike as low as 125 before attempting to put in a bottom.

If Gold trades below 1080 for 2-3 days in a row, it should lead to a test of the 980-990 ranges. A weekly close below the 950-970 ranges would be the first sign that Gold could potentially mount a much stronger correction than most are expecting.

The Euro is facing a host of problems and rather than repeating them all we have attached an extract from the Jan 5th market update titled "Euro woes" that was sent out to our subscribers that covers this topic in detail.

Euro Woes

The European Union established the growth and stability pact which imposed the following two conditions on all members

  1. Deficit spending cannot exceed 3% of the GDP

  2. Total Government debt should not exceed 60% of GDP

The table below clearly illustrates that many of the members are blatantly ignoring these rules.

Country

Budget Deficit as % of GDP

Debt as % of GDP

Greece

-12.7%

113%

Portugal

-9.6%

53%

Italy

-5.0%

115%

Ireland

-12.2%

65%

Spain's budget deficit could reach 90% of GDP by 2011, currently it is roughly at 60% and rising, so we have yet another contender to join the list of troubled nations. S&P has already downgraded Spain's sovereign AAA credit rating. In fact, at this point Germany is the only country in the EU that deserves the AAA rating, the rest all face varying degrees of trouble.

Germany the head honcho is in no mood to lend money or help its fellow members as they have their own problems. Now a strong currency makes it hard for struggling countries to make their exports attractive by devaluing their currency. Under the one currency umbrella, they no longer have this option. For example, Italy had a history of systematically devaluing the lira when faced with tough economic conditions; this option is no longer available. Thus the next step is to simply openly flaunt the rules. If no punishment is forthcoming for breaking these rules, then there is nothing to stop other members from joining the party.

Thus there is a very good chance that something could crack here and that the Euro might not end up being as safe as so many make it to be. While the US has problems, the problems facing the EU are starting to look even more daunting. Look at the table above all 4 nations are openly flaunting the rules laid by the growth and stability pact, actually when we add Spain to the list, the count rises to 5.

This situation is going to create rifts in the EU as weaker nations now have to adhere to a fixed standard without having any flexibility to adjust monetary policy based on their own needs; the only option then is to openly flaunt these rules. This in turn is going to aggravate the larger stronger players such as Germany and France, which could possibly lead to one of the following outcomes.

Some members could be kicked out (very dramatic move and not likely right now)

Members could start to openly revolt against these rules and make demands to ease them or ask for lengthy time extensions before coming into compliance.

Finally, the richer members might be forced into bailing out their weaker neighbours.

Either of the developments could have a very strong negative impact on the Euro. So when we look out the window it appears what we stated many times in the past might become a reality. "Every currency is rotten" and the rats are jumping from one sinking ship to another. We are also very close to entering competitive devaluation stage or what we have coined as "the devalue or die era", where every nation in order to gain an exporting edge starts to devalue its currency.

Thus individuals should not smugly gloat over the dollar's demise, for they might be missing the real trouble that is taking place in their own backyard. This problem facing the EU is another reason why the dollar could potentially mount a stronger rally than most expect and why it might even potentially surpass all our posted targets. When the ship is sinking panic takes over and people jump before they look. Thus if anything out there makes investors feel skittish about the Euro, it could potentially trigger a mad rush for the exits. Are we saying this is definitely going to occur? No we are not but given the large deficits 5 members in the EU are running; it's safe to say that all is not well and that the situation could take a turn for the worse very rapidly. Greece could turn out to be another Iceland, if they do not get their act together very very fast.

Very important final factor

The US dollar for all its current woes is at least backed by the full faith of the US government; the Euro in contrast is backed by nothing. No one nation backs it, it's backed by a group of nations whose economic conditions could/might force them to eventually abandon the Euro (strong examples right now are Greece and Italy, Spain and Portugal are not far behind). Going forward the currency markets are going to become increasingly complex and entangled. This is the reason why we have pushed our subscribers over the years to make sure they have a core position in bullion (Palladium, Silver and Gold).

Conclusion

The potential for the dollar to mount a very strong rally increases with the passage of each, especially in light of the recent negative developments in Greece. A breakdown in Greece could trigger a domino effect by first affecting other weak countries such as Italy, Ireland, Spain and Portugal. A strong rally in the dollar by default is going to lead a strong pull back in the Euro and this could in turn lead to a much stronger than expected pull back in Gold.

However, the bright spot is that a strong pull back in Gold should be viewed as a tremendous buying opportunity if it comes to pass. The long term trend of the dollar is still down and is not likely to change but it could produce a lot of acid for those betting against in the short to intermediate time frames. The long term in the Gold is up and the pattern is projecting much higher prices in the future, though in the short term the volatility is going to give short term traders a headache. The Euro on the other hand is the one where potentially things could fall apart. Several members are in trouble and thus one has to be open to the potential that the Euro could fall apart. The key word to focus on is potential.

"Remember, if you ever need a helping hand, you'll find one at the end of your arm ... As you grow older you will discover that you have two hands. One for helping yourself, the other for helping others." ~ Audrey Hepburn

Related articles
The Dollar, Euro and Gold
The Gold Bull; time for a breather or?
Bonds and Gold

 


 

Sol Palha

Author: Sol Palha

Sol Palha
TacticalInvestor.com

Sol Palha is a market analyst and educator who uses Mass Psychology, Technical Analysis and Esoteric Cycles to keep you on the right side of the market. He and his partners are on the web at www.tacticalinvestor.com.

The information contained herein is deemed reliable but no guarantee is made about its completeness or accuracy. The reader accepts this information on the condition that errors or omissions shall not be made the basis for any claim, demand or cause for action. Any statements non-factual in nature constitute only current opinions, which are subject to change. The author/publisher may or may not have a position in the securities and/or options relating thereto, & may make purchases and/or sales of these securities relating thereto from time to time in the open market or otherwise. Neither the information, nor opinions expressed, shall be construed as a solicitation to buy or sell any stock, futures or options contract mentioned herein. The author/publisher of this letter is not a qualified financial advisor & is not acting as such in this publication. Investors are urged to obtain the advice of a qualified financial & investment advisor before entering any financial transaction.

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