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Market Report: JPY Carry Trade Reversal?

In my last article I left readers with the potential idea of a peak in the US markets, although we saw a minor pullback, it was not the move or the initial decline I am expecting.

Although this minor new high in the SPX has caused me to adjust my wave counts a little, the thesis is still on track and I am expecting a large decline in the markets, in the early part of 2014.

Bearish Idea

S&P500 Weekly Bearish Idea Chart
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I suspect this last spike we have seen over the past week is wave 5 of [5], so whilst it can push a bit higher I do think it's close to a reversal.

Bullish Idea

S&P500 Weekly Bullish Idea Chart
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Even my bullish alternative wave count suggests the likelihood of a pullback; although I use the term "pullback" loosely it seems this market is hell bent on destroying anyone that even breathes the word pullback. The last high has put in a RSI divergence, so unless the market goes into some sort of parabolic advance I am looking for a large reversal, as both ideas suggest the market is due a correction.

If however the market decides that it is not interested in correcting and wants to do a "Naz 2000" then I will simply concede I am wrong and the market clearly has another agenda, far different to my thoughts.

Carry Trade Unwind (or return of the carry trade unwind)

For those of you reading this article and have been around the markets a long time will no doubt have heard the term "carry trade" more so the JPY carry trade.

For those of that do not understand what this is, it's basically borrowing JPY at low rates and using that JPY to buy other assets that have a higher yield. The most recent carry trade is the 2013 melt up in the Nikkei 225 and USDJPY, if you overlay those 2 markets you can clearly see they are pretty much tick-tick. I can't remember the stats but I read it was something like a 94-95% correlation. We can clearly see it's a close match.

USD/JPY versus Nikkei 225 Chart

So hedge funds have been borrowing the JPY and leveraging up and buying Japanese stocks. In effect they have been selling short the Yen, 2013 will go down as the "year of the JPY carry trade".

You are probably asking yourselves, have hedge funds bought US stocks?

The answer appears to be yes as seen in this chart.

USD/JPY versus ES Chart

USD/JPY versus ES Chart 2

Notice how the low in the US markets in 2011 virtually aligns with the start of the move in USDJPY. (I am using the ES e-mini contract as a barometer of the US markets)

So it seems the clues to the US markets moving higher is back to the JPY carry trade as I have shown in the charts above.

Now you are probably thinking, hang on a minute I thought QE (add the number after I lost count) is the cause of the US markets going higher isn't it?

Well initially you would be right, but since 2011 it seems that's not the case as seen in this overlay chart of the USD$ and ES.

DX versus ES Chart

So since 2011 it's not a US$ carry trade as it was from 2009-2011, it's now become a market that appears to be reliant on the funding from the JPY.

Now no one is ever going to come out and tell us that the FED is buying stocks indirectly via the primary dealers such as Goldman Sachs or JP Morgan etc, I would expect some part of QE to be going into US stocks, but I think the US stocks markets are actually now more dependent on the JPY carry trade. More so than QE from the FED. I think the correlation between QE and US stocks is lower than the correlation between the JPY carry trade on US stocks.

So It's my belief that the reversal of the JPY carry trade will likely see a reversal in US stocks, as the system is heavily leveraged the smallest of reversals can cause a ripple effect that can snowball out of control due to the compounding effect.

If my thesis is correct and if the JPY carry trade unwinds then shouldn't we be watching the Nikkei-225 and USDJPY? Well that's exactly what we at wavepatterntraders.com are doing.


Back in Jun/Jul 2013 I was looking for a sideways triangle pattern based on the fact I suspected USDJPY was in a large 4th wave, so a period of consolidation was needed before a final 5th wave towards 104-105.


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The USDJPY has now hit my target zone area, the sideways chopping price action has also been seen on the Nikkei-225 as well, and subsequently that market has thrusted higher virtually in sync with the USDJPY pair.

It's that thrust that I believe is the key component and a potential clue to both the Japanese markets as well as the US stock markets. A triangle is very commonly seen in the position of a 4th wave, of a 5 wave pattern (an impulse wave has 5 waves) so with the new yearly highs on USDJPY and Nikkei-225 it has the potential to be a warning sign to bullish investors that a correction/decline is setting up early in 2014.

If my idea is correct and both the Nikkei and USDJPY have thrusted higher in a 5th wave out from a triangle, then the next move is a strong reversal lower, hence the idea of a reversal on the US markets.


Nikkei 225 Chart

YM (Dow Industrials)

YM Chart

Both the YM and NKD count well as a 5 wave advance from the 2011 lows, if the count is correct then the markets are setting up for an impending reversal.

YM versus Nikkei 225 Chart
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A correction/decline fits in with my ideas on the US stocks markets as I wrote about earlier in this article. So as it stands we potentially have a peak close by on USDJPY and Nikkei-225, if the JPY carry trade does unwind, then I am expecting it to ripple through other markets which include US stocks.

We can clearly see that the US stocks markets have a very high correlation with the JPY from the lows made in 2011, if both USDJPY and Nikkei are finishing a final 5th wave from the 2011 lows, I am expecting a large move lower in those Japanese markets, hence US markets move lower in sync.

Gold Reversal Setting Up

So if we were to see some fear from stocks selling off, which markets could benefit?

That answer in my opinion will be Gold and Gold stocks, the beat down from the last 2 years is likely drawing a close, I see many setups in Gold stocks and Gold and I have actively been following Gold related markets for members for a while now, I really do think 2014 will be the year Gold stages a fight back.

It still appears that Gold is in a large 5th wave from the 2011 top.

Gold Weekly Chart
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Now you don't have to be a genius to work out the fact that Gold has been puking as stocks have been rising, yet did you noticed when Gold stopped? 2011 to be exact, kind of strange don't you think that we have a potential 5 wave advance near a conclusion from 2011 in the USDJPY and NIK-225 as well as a potential 5 wave move from the 2011 lows in US stocks (shown by the YM chart above).

Yet it also appears that Gold is nearing a 5 wave decline from 2011.

So a thesis that I wrote about a few weeks back suggested that if the US stocks reverse so should Gold and Gold stocks.

But now we can add another market into the mix, the JPY carry trade aka 6J futures.

Gold versus USD/JPY Inverted Chart

It seems to me that if the JPY carry unwinds we most likely see a reversal in both Japanese and US stocks as well as a move back into Gold and Gold stocks.

Ask yourselves this question, where would you stick your $$$ if a market peaked and unraveled? Wouldn't you do exactly the same as Gold bulls did in 2011/2013 and sell anything related to Gold and put into US stocks.

Remember US stocks were at their lows in 2011, coming off a large scary decline, yet Gold and the HUI was moving into the peak in 2011 and topping out a bull cycle. So traders simply moved out of Gold stock into US stocks, I suspect the same is going to happen again and we see a reversal shortly in those same 2 asset groups.

Now flip that same scenario only we have the potential for US stocks to peak and Gold and Gold stocks to put in a low.

Remember that USDJPY and Nikkei have a possible 5 advance move from 2011 lows.

Japanese Yen versus Gold Chart
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Kind of bizarre seeing Gold and 6J potentially ending a 5 wave move, if that is the case it only strengthens my thesis of a reversal in asset markets, as the JPY carry trade unwinds, $$$$ will move back out of US and Japanese stocks and go into Gold and Gold stocks.

Remember I am presenting this idea BEFORE this scenario plays out, but if it's correct a huge opportunity is around the corner in many markets.

I am following many Gold stocks as well as the metals and whilst I don't think a low is imminent, I do think the early part of 2014 will see Gold and Gold stocks put in a low and mount a sizeable correction, one that will be a shock to most traders.

I will leave it there for now.

I want to wish readers a happy new year and look forward to prosperous 2014.


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