Rudi's View | Mar 25 2010
By Rudi Filapek-Vandyck, Editor FNArena
Those readers who have kept track of my musings and analyses over the past year or so know fully well that I am a keen follower of movements in currency markets.
This wasn't always the case. As a matter of fact, I like to use every opportunity I can get to quip that in order to accurately predict currency movements, all one has to do is throw a coin up in the air and choose either heads or tails.
It's an old joke, used once upon a time by Alan Greenspan, when he was still governing the Federal Reserve.
But those were different days. Many a market observer has noted over the past two years or so that currency movements often precede directional changes in equity and commodity markets. This has led to a plethora of alternative FX signals and indicators becoming popular over that period.
US market trader Dennis Gartman, for example, has been for a long time a keen watcher of the euro versus the yen cross. However, this month Gartman noted the one-on-one correlation with US equities has fallen apart. Another indicator that seems to have lost its usefulness.
Others have tended to watch closely the AUD against the euro, the USD, or the yen.
I have always preferred to look at EUR/USD and the cross has thus far never failed me as a highly accurate indicator (knock on wood).
To put it very simply: if the euro strengthens against the USD, this indicates global risk appetite improves, and thus equities and commodities attract buying support. If the USD claws back lost territory on the euro, the opposite happens.
More recently, quite a few market commentators have been suggesting the predictive value of USD movements has become questionable too. They tend to look at the final result for the EUR/USD at the end of the US trading session, or alternatively at the final result for the USD Index.
According to my observations, these experts are making two key errors in their judgement. Firstly, the correlation is never and will never be a 100% exact one-on-one measurable relationship. In other words: stating that gold has only fallen by this much while the USD strengthened by more is pretty much missing the point: it's the directional impetus that counts.
As far as I can judge from personal observation: the high accuracy has remained intact since gold gave up on US$1200-plus in early December last year.
The second error is using final values instead of intra-day movements. Often, and as often pointed out by colleague Greg Peel in FNArena's Overnight Report, risk assets will reverse course, by giving up (part of) earlier gains or reducing (part of) earlier losses throughout a given trading session – and they do so at the very same moment the USD changes direction.
A few weeks ago, I set up my PC so that I have live updates for EUR/USD and various other key market indicators (gold, copper, you name it). I have found the direct correlation between EUR/USD and Australian equities nothing less than stunning.
While many investors will give up an arm and a leg to have live access to US futures for equity indices, I simply gaze at a two decimal figure on my desk top and I know what's happening in the market.
Let's take today (Thursday) as an example.
Early this morning I sat down behind my PC and saw a significant fall in the EUR/USD value compared with late yesterday. I immediately assumed gold, oil, base metals and US equities had taken a hit overnight, especially since I also spotted a significant fall in the AUD/USD.
I was correct. (Only then did I venture off on the internet to try to find out why exactly).
Then, as the Australian trading session developed throughout the morning, I noted the euro was attempting to claw back some lost territory on the USD. An instant later I hear the voice on the financial TV station in my room announcing the Australian share market is making some kind of a come back from earlier losses.
Surprise, surprise? Not really.
It didn't take long before the euro started weakening again, and guess what? The Australian market has reversed direction too.
“The Australian share market is showing some greater losses, though the market is off its lows for the day”, says the voice at the other end of the room.
I know, because I have this “one point something” value on my desk top and as it changes every now and then, a tick here and a tick there, right in front of me, it simply doesn't want to fail.
More importantly, it's free, available to everyone with internet access, and it summarises and translates all that's going on between Beijing-Moscow-New York and Sydney instantly into one number anyone can understand.
Is it up? Good news. Is it down? Not good.
The negative news is now that the euro has sunk below another technical support level overnight that was widely considered very important. The talk going through global financial circles now is thus what the potential implications might be.
On its way to 1.30 is what the bears have to say about it. That's a lot of weakness from a level of around 1.3327 at the time of writing this story.
If this prediction proves correct I wouldn't be surprised to see a genuine share market pull back (not the half-baked one we're witnessing today). And that, believe it or not, would simply be in line with what global equities have been doing since mid-last year anyway.
Note that these types of alternative indicators tend to have a limited life-span only. Like once upon a time Chinese energy consumption provided investors with the best indication about the strength of the economy and like the Baltic Freight Indices showed us instantly what was happening in global trade and demand for base materials.
The EUR/USD indicator is not going to work forever and ever. At some point the USD will move in line with the US share market. Until that point of reversal has been reached, however, I'll be looking at my desk top and drawing very simple conclusions.
Up? Good. Down? Not Good.
I do also pay attention to the USD Index, by the way, but I don't have that one live on my desk top (at least, not yet).
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