On October 5, 2004 we published the following chart showing the next four moves we expected the dollar to make.
With seasonal trends pointed down into the end of 2004 we forecasted a test of the key 80 level followed by a rally to 91/92 in July. We also forecast that once the dollar did rally off the 80 support level the media would shift its focus from the "trade deficit" to "interest rates." Have you noticed how many fewer references there are to the trade deficit this year? Its no coincidence. The media "rationalizes" moves in the market and currency analysts simply follow the trends. They do not make long term forecasts. If they do, they are usually wrong.
One year ago this forecast stood all others on their heads. But our rational was that the US would see higher short term and long term yields. Following that "unexpected" rally from January to July 2005, we expected a pullback to the key 85 level between August and December of 2005. Then, a renewed rally to the 100 handle in 2006. By mid-September we alerted subscribers that the forecasted correction had ended prematurely and that the next big move for the dollar was up.
Amazingly, the dollar has followed our suggested moves around key pivot points perfectly (compare the top chart with the updated one below). We now think the final phase of the dollar rally (leg #4) is now underway.
Longtime readers know that we prefer to follow the relative direction in short term rates as the key indicator of interest rate expectations. By following moves in the 3-month Tbill relative to longer term maturities we can accurately gauge where the market thinks rates are going. By extension we can forecast the direction of the dollar. But long term rates are also a handy indicator as a spike in interest rates often will coincide with a rally in the dollar.
In the next chart below we show the 30-month cycle in 10-year Treasury yields that bottomed last month. Note that in each case (blue boxes) this has preceded a sharp rally in the US dollar. This is yet another reason we remain bullish on the dollar's prospects and think that today's low 88.75 offers a good buying opportunity in the dollar for those that have not yet gone long. As such, we now expect a move to 95/100 over the coming months to cap the dollar's counter trend rally which will set up the next vicious bear market decline.
Finally, one point we made at last year's Las Vegas Traders Expo was that everything you trade is priced in some currency.
Therefore, a helpful tool is to look at everything priced in gold to compare real gains to phantom gains. Another helpful tool is to compare long-term trends in currencies and commodities as long as both are priced in the same currency.
In the chart below we show the 32-year chart of copper prices and the Swiss franc - both priced in ever depreciating US dollars.
Note that copper prices are testing a 30-year rising trend line that has capped all previous rallies. Subsequent declines were vicious and seem to work independent of gold prices which moved higher all through the 1970s without suffering a collapse as you see here. (Remember that we are bullish on gold but want to wait for the US dollar rally to complete its move before cycling back into gold).
The orange lines show that the major tops in copper lined up perfectly with equally significant highs in the Swiss franc. Now recall from last week's report that the 10-year Treasury yield is breaking out to new highs in conjunction with the 30-month cycle bottom just as junk bonds are collapsing. Rising rates = tighter money = stronger dollar.
The final observation is that copper appears to make a "three step" move when it screams to new highs every ten years or so. It looks like copper made another three steps with this month's high meaning a reversal is now immanent. As such, we feel the dollar is poised to rally significantly in the coming months, while copper should see at least a 30% retracement of recent gains.