What Are the Commodity Currencies Telling Us?

11/04/2009 12:01 am EST

Focus: FOREX

Recently, the media has been very focused on the US dollar. Remarks about its behavior are becoming ubiquitous, if predictable. Same for the Japanese yen, which also earned a title of being a “safe haven.” This pushed the commodity currencies into a background. They have been the attention magnets for the better part of the year. As we know, the commodity currencies belong to countries that export huge amounts of raw materials. Their economies largely depend on prices of physical commodities and on the general health of global economy. These are Australia, New Zealand, and Canada. Some would add South Africa, Russia, and to a smaller degree, Brazil, into this camp. One could say that a very simple, yet accurate, barometer of world economic climate is the Australian dollar-Japanese yen cross. If this pair is moving up, things are good or on the rebound, while a falling AUD/JPY indicates either existing or future problems.

This pair, and all others in this camp, like NZD/JPY, CAD/JPY, as well as their crosses with USD, CHF, and so on, have been rising most of this year. Recently, these strong moves have been developing signs of resistance and maybe even possible reversal. Here is a weekly chart of NZD/JPY, very representative of how most of the crosses look right now. Price advanced from a low of about 44 early in the year to above 69 recently. This is a huge move, which only looks small on this chart because of severity and historic nature of preceding drop. If a Fib retracement tool is overlaid on this graph, we can see that the price is between the 38 and 62 levels, an area where reversals are very common.

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This general zone is also a resistance level at around 68, which used to be strong support a couple years ago. Change of polarity effect. Also, 100 SMA, which I use as dynamic trend line, provided resistance recently. Last week’s candlestick formed a large bearish engulfing line pattern, which I consider to be a strong formation. None of these alone would be worrisome, but coming together in confluence point towards a very possible market reversal is. The daily chart is becoming negative as well.

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The last few days have been very volatile, not just for NZD/JPY, but for all crosses of commodity currencies. Daily trading ranges simply exploded to levels not seen in a year. For example, four-day ATR has the highest reading since November 2008, towards the end of that panic. This itself could indicate possible start of a correction. For now, the daily chart offers a strong support at the 63 level, which was tested last night. Should price break under that line, chances are good for a move to 57.50 or so. I will be watching this level closely.

On the surface, selloffs in these crosses don’t make any sense. With recovery seemingly underway, yen should be getting weaker and the commodity currencies should be roaring. I, for one, have hard time looking for sell setups in the yen crosses. It goes against my long-term views, but charts don’t lie! They can be misread, but if price is painting a bearish picture, I must at least acknowledge it. For any larger fall in these pairs, we would need a catalyst, and I don’t know what that could be; we will find out after the fact. One possibility is an announcement from a central bank. For example, Reserve Bank of Australia has another policy meeting later on this week, with strong expectations for an additional rate hike. Lack of action there could initiate a selloff. This is pure speculation, but it should illustrate how a selloff might come about.

I am not planning a large-scale selling campaign just yet, just watching markets and outlining some possibilities. This line of thought will be continued if needed, using NZD/JPY as a proxy for all crosses of interest since it would appear to be most vulnerable. For now, focus is on shorter time frames, which for me are the hourly and four-hour charts.

By Mike P. Kulej, trader and blogger, FXMadness.com

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