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Adam Hamilton

Adam Hamilton

Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing…

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Currency Countertrends 2

It is not very often that currencies dart to and fro with all the vigor of stocks, so the extraordinary currency volatility we witnessed this week was a rare treat to observe. Contrary to popular expectations, trend changes seem to be in the winds.

While this action has been building for about six months now, the immediate news spawning this week's sharp moves swirled around the French and Dutch votes soundly rejecting surrendering their national sovereignty in favor of the European Union Constitution. These votes were thoroughly entertaining and I must digress into politics briefly. Forgive me.

It was really funny to watch the hysterical antics of the Eurocrats in Brussels after these votes. Calling it a crisis, they acted as if an asteroid had pulverized Europe into a smoldering crater. Bureaucrats, since they willingly decide to live as parasites on society rather than taking up an honorable living producing a good or service that people actually want to buy of their own free will, can only grow their fiefdoms by usurping power from the people.

But people are born to live free, not to be ruled, with their ultimate achievement limited only by their determination. No freedom-loving person anywhere wants to yield precious national sovereignty to foreigners. Heck, my blood boils just having Washington extort away almost half the fruits of my labors every year, but if my taxes were paid to a foreign capital I would probably leave America forever.

Is it any surprise that the French and Dutch people don't want to be ruled by foreign bureaucrats based in Belgium totally unaccountable to the French and Dutch electorates? Not to me. But lest the one-world crowd wax too glum, I suspect the ultimate rise of the European Superstate is a certainty. Just as in local politics, European leaders will continue to hammer their citizens with this issue over and over until the people finally give in and surrender their sovereignty.

While Eurocrats acted shocked that free men don't want to be ruled by foreigners, the euro was sold off like it was toxic waste. This was amusing too, as the euro currency has been phenomenally successful since its introduction in 1999. The euro has, in an inconceivably short time, become the second most important currency on Earth. It has made European commerce and travel vastly easier and it is challenging the dollar's global supremacy.

Since the euro's sub-$0.85 lows in summer 2001, it has relentlessly marched higher to over $1.36 at the end of 2004, a dazzling 60% gain! Over this 3y+ period of powerful euro secular bulldom, for how many months were France and the Netherlands living under the EU Constitution? Exactly zero.

And since the euro's all-time highs of $1.36 in the final days of 2004, it has been grinding lower in a correction. While the French and Dutch votes only happened in the past week, the euro has been moving lower for five months now. While we can debate how long pollsters have expected an EU vote defeat, I bet it is only over the past month or so. This leaves the first four months of 2005 where the euro fell yet France and Netherlands weren't under the EU Constitution and the vote results remained yet future.

So while this week's votes catapulted currencies back into the news, the results are not responsible for either the multi-year primary trend or the multi-month intermediate trend in the euro and dollar. The votes simply preserved the status quo, changing nothing. Both countries went from no EU Constitution to no EU Constitution.

Ever the heretic, I submit that perhaps the euro plunge and dollar surge of this week were not due to wailing bureaucrats. Maybe the news just briefly amplified the current intermediate currency trends that were already in force for five months before the elections. Maybe Europe won't cease to exist and its fine citizens will go on living their lives as they have for all of history through countless governments.

From my speculator's perspective, the dollar and euro moves this week just look like what may be the final surges in currency countertrends. Every secular bull or bear market, in the currencies or anywhere, usually travels in line with its primary trend. During these primary moves the market diverges from its key 200-day moving average, pulling farther away. Bulls march above their 200dmas while bears sink below.

But periodically a countertrend move is inevitable. No market, no matter how powerful its secular trend, moves in a straight line forever. They all take two steps forward and one step back. Bull markets' countertrend moves are in the form of periodic corrections that force prices to converge with their 200dmas briefly. Bear markets' countertrends are the exciting bear rallies that also force a temporary 200dma convergence.

These countertrend moves must happen periodically to rebalance sentiment. After a bull-market upleg speculators are too euphoric and complacent so a correction bleeds out the greed and forces a balance. After a bear-market downleg speculators are too negative and frightened so the bear rally blasts away the fear and restores sentiment balance. The markets abhor sentiment extremes and work naturally to rebalance them, self-eliminating anomalous levels of greed and fear.

Back in January I wrote an essay discussing this common phenomenon, "Currency Countertrends". At the time the dollar and euro had just reversed and they remained stretched far away from their 200dmas. Back then I concluded...

"The bottom line is temporary currency countertrend moves are necessary, healthy, and should be expected periodically. They deftly bleed the air out of sentiment imbalances that breed when secular trends diverge too far from their anchoring 200dmas. Once these countertrend reversals are underway though, they tend to run until all three major currencies fully converge with their own 200dmas."

The third major currency, of course, is gold. Gold has been the ultimate sound money for six millennia of human history, totally immune to the endless schemes by bureaucrats to defraud their citizens indirectly by debasing currencies. Since our secular gold bull remains in Stage One it is highly dependent on the action in the US dollar, which is directly affected by the short-term fortunes of the euro.

By late 2004 all three currencies had stretched too far away from their 200dmas and countertrend moves back to convergence were inevitable. The currencies had flowed with their primary trends for long enough and the periodic ebbing was due. I warned our subscribers about the coming highly-probable gold correction on December 1st (12/04 ZI) days before it began and wrote about it publicly a couple weeks later in "The Relative Dollar and Gold 3"...

"While not exceedingly extreme yet, both the dollar and gold are getting relatively far from their respective 200dmas so we must be very vigilant for the increasingly probable reversals. A major dollar bear-market rally and major gold correction lasting for a few months are nothing to worry about for those prepared for the risk, but for those who aren't their capital can evaporate rapidly. Please be careful here!"

The dollar bear rally, as well as the parallel euro and gold corrections, were anticipated in advance six months ago for pure secular technical reasons and had absolutely nothing to do with the European Union's success or lack thereof in usurping national sovereignty! This week's news merely extended already-existing currency countertrend moves.

Our charts this week updated from my original essay help illustrate this crucial point for investors and speculators to understand. The primary trends in all three currencies as well as their latest countertrends were well underway for months before the French and Dutch votes even grew into an issue. It is important to view all three of these charts at once, as they together contribute to one core market story.

After diverging far below its 200dma in late 2004, the dollar was due for a major bear-market rally as I warned in early December. This countertrend move, just like the five before it, bled off excessively pessimistic sentiment and led the dollar to converge with its 200dma. The EU voting news blasted it above its bear-rally intermediate-trend resistance this week, probably temporarily.

The upstart euro has grown into the mighty dollar's nemesis, it feeds off the dollar's weakness and is becoming more and more accepted in global commerce. The vertical blue lines above highlight the dates of major reversals between the euro's primary uptrend and its periodic countertrend corrections. Naturally these reversal dates correspond almost exactly to the dollar's above. This week's votes bludgeoned the euro under its intermediate correction support, likely not for long though.

Finally gold, very much dependent on the dollar at this stage in its young bull, retreated on dollar strength. The gold reversals from primary trend to countertrend corrections match those of the dollar and euro rather well. Once again please consider all three charts at once and note that all three currencies tend to run with their primary trends or converge to their respective 200dmas in countertrend moves over the same periods of time.

Each primary trend is noted above, a best-fit line drawn through the 200dma which in and of itself filters out the endless day-to-day market noise. The primary trend of the dollar is down, a secular bear market, while the primary trends of the euro and gold remain up, secular bull markets. These primary trends have been in force since at least the summer of 2001 and compel speculators to make a crucial decision today.

Are the intertwined dollar bear and euro/gold bulls ending? Have this week's EU Constitution votes and the resulting currency volatility fundamentally changed the destiny of the dollar, euro, and gold in the coming years? Or will the primary trends reassert themselves as the dollar bear rally and euro/gold corrections come to an end? Your decision at this crucial juncture in time may have profound influence on your future wealth.

As far as I can tell no fundamentals have changed. The US dollar's secular bear remains intact. The Federal Reserve prints dollars as fast as it can and the politicians and bureaucrats in Washington spend them like there is no tomorrow, relentlessly debasing the dollar into oblivion. Every single nation that has ever tried this foolish monetary strategy since before the Roman Empire has ultimately ended up annihilating its own currency in the end. And dollar supplies continue to soar while global demand is waning for economic and geopolitical reasons, a bearish omen.

Meanwhile the euro, whether the Europeans like it or not, is largely in a bull market because it is the only viable fiat alternative to the rapidly eroding dollar. Everyone from extremely wise Americans like Warren Buffett to Persian Gulf oil sheiks to Asian central banks are diversifying into the euro because they are so tired of losing purchasing power in the dollar. If the dollar continues lower as it ought to on fundamentals, then odds are the euro bull will persist.

And gold, in addition to being a sound-money alternative to all the world's pathetic fiat currencies, has outstanding fundamentals of its own. We are in a secular commodities bull likely to last another decade or more, and gold has always been one of the easiest ways for investors to get leveraged commodities exposure. I wrote an essay in February outlining gold's extremely bullish fundamentals.

With the Fed and Washington hellbent on inflating the dollar into oblivion and a powerful secular commodities bull underway for unstoppable supply-and-demand reasons, I don't think the EU vote this week has a snowball's chance in hell of prematurely ending the existing primary trends in the dollar, euro, and gold. The countertrend moves we have seen since December merely look like garden-variety periodic 200dma convergences.

And if you consider the facts yourself and decide you agree with me that today's primary secular trends are likely to persist, then the trading strategies of choice for the coming six months to a year become readily evident. In secular trending markets whenever a price converges with its 200dma the best bet to make is that it will once again diverge from its 200dma as its primary trend reasserts itself.

In order to more precisely quantify where a price happens to be relative to its 200dma, I developed a technical tool I call Relativity to yield more precise trading signals. By dividing each daily close by its 200dma and charting it over time, a horizontal relative trading band is created. A multiple of the 200dma meanders between a relative long signal on the bottom and a relative short signal on the top. This technique is very successful in trending secular markets.

All three charts above contain our current relative trading bands for each currency, slaved to the left axes. Note that the rDollar has given a strong short signal while the euro and gold are now flashing strong long signals. Each chart separately signals that its individual countertrend move is mature and buttresses the other charts. Probabilities are now greatly in favor of the primary trends reasserting themselves. These technicals agree with the fundamentals.

So if our Relativity signals prove correct yet again as they have so many times in these secular moves to date, the dollar is due for its next major bear-market downleg and the euro and gold are in for major bull-market uplegs. Their countertrend moves appear to have run their courses and the final emotional surge on the non-news of the EU Constitution status quo continuing confirms the countertrends have influenced sentiment for too long now.

Nothing has changed in Europe yet currency traders remain irrationally pessimistic! The euro has done quite well as an upstart currency challenging the dollar's global hegemony for years even though France and the Netherlands never had ratified the EU Constitution. The euro was bathed in fear due to its mature countertrend correction even before the elections which just exacerbated it.

The same thing is true in the dollar and gold. Even though nothing has changed in Europe, the dollar has been rising since December so traders are naturally extrapolating this trend out into infinity as they are wont to do. The dollar's countertrend move has bred far too much greed and complacency which is the ideal breeding ground for a major new downleg to spawn. The emotional dollar surge on the euro non-news highlights this dollar countertrend's maturity.

Gold might be the only sane currency out of the bunch. While it was pressured by this week's dollar surge, it refused to move as dramatically as the dollar and euro. Gold investors are used to seeing our bull market climb a wall of worries and it usually takes more than just an unchanging political status quo to capture our attention. It is in this gold market, not paralyzed in fear like the euro or drowning in complacency like the dollar, that the greatest currency trading opportunities emerge.

While one can throw long the euro or long gold or short the dollar in the futures markets, futures-trading accounts are still very uncommon compared to stock-trading accounts. And since the US and Europe are not publicly traded companies, it is not possible for stock traders to buy the euro and sell the dollar in the stock markets. There are no stocks that produce euros or dollars severely limiting stock traders' opportunities.

But gold, the oldest currency in the world and the only one to survive every government, moves in parallel with the primary euro bull in response to the secular dollar bear. Going long gold, or in the elite unhedged companies that wrest it from the bowels of the earth, is in effect going long the euro and shorting the dollar at the same time. Sooner or later global investment demand will lift gold independent of the currencies, but for now it moves with them.

We have been relentlessly studying gold stocks at Zeal since 2000, before their secular bull was even born. There have been five major uplegs in this gold-stock bull to date averaging 98% gains each and I suspect that the sixth is imminent since the currency countertrends have finally reached maturity. Gold stocks are a wonderful way to ride the primary currency trends since they tend to leverage gold dramatically.

We have been preparing for this expected sixth major gold-stock upleg non-stop for six months now, the entire currency countertrend period, painstakingly analyzing hundreds of major and junior gold stocks, both fundamentally and technically. The brand new June 2005 issue of our acclaimed Zeal Intelligence newsletter, hot off the presses, outlines 8 elite gold and silver stocks that ought to thrive when the currencies' primary trends resume. It is not too late to buy them now, but the biggest gains will flow to those in the earliest.

This June newsletter also discusses the recent gold-stock correction and explains how we pick stocks at Zeal. I also have 4 open stock-options trades handpicked with the potential to greatly leverage the probable gold and silver uplegs that the currencies' primary trends resuming are likely to ignite.

You ought to join us today before these rare opportunities pass you by! First-time electronic-edition subscribers will receive a complimentary copy of the new June issue. As an added bonus all of our subscribers get private access to big rDollar, rEuro, and rGold charts updated twice a week on our website so you can follow the relative currency trends yourself.

The bottom line on the exceptional currency volatility this week is that France and the Netherlands just voted to preserve the status quo, they did not nuke Europe. The mourning Eurocrats are power-hungry drama queens, they will live. The euro was retreating and the dollar advancing in anticipated countertrend moves since late last year, many months before this week's entertaining spectacle.

These countertrends have probably fully run their courses, they were already maturing but the EU votes pushed them to extremes. Unlikely to be sustained, these extremes will probably soon yield to major reversals and currency moves running with their primary trends. This portends a major dollar bear-market downleg and major euro and gold bull-market uplegs. The currencies will once again diverge away from their 200dmas.

If this indeed proves to be the case, then the precious metals and the best of the companies that mine them are likely to thrive in dazzling new uplegs in the next six months to a year. Don't be left behind.

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