Forecasting The US Dollar

02/15/05 11:24:40 AM

by Koos van der Merwe

It has now been three years since the Canadian dollar started strengthening vis-a-vis the US dollar. Can the Canadian dollar be used to determine what is going to happen to the US dollar?

Security: US$
Position: Sell

Last week, for the first time, I saw mention in the media that should the US dollar continue to weaken, the possibility exists that gold and other commodity prices may be quoted in euros. Should this happen, the US dollar will weaken rapidly because the demand for US dollars to buy commodities will lessen. The question we can consider at a later time is: Does the dog wag the tail, or does the tail wag the dog? Does the US dollar decide the price of gold or vice versa? If commodities were to be priced in euros, and the euro were to become the prime world currency, how much further would the dollar fall?

We can also ask: Against which currency should the US dollar be compared, the euro or the yen? The Chinese yuan is fixed to the US dollar, so it is effectively out of the equation. Finally--and this is a theory that has been put out by many Canadian economists--will the Canadian dollar reach parity with the US dollar within the next two years?

Figure 1: The Canadian dollar, sterling, euro, and yen. Here's a chart of various currencies against the US dollar. If you look at the chart carefully, one thing becomes obvious: Most of the time, the peaks and the valleys move in tandem for all the currencies.

Graphic provided by: MetaStock.

Graphic provided by: Advanced Get.

Figure 1 is a chart of various currencies against the US dollar, namely the Canadian dollar, the sterling, the euro, and the yen. The chart looks very busy, and it is, because I have plotted the currencies on the chart without a price correlation. However, if you look at the chart very carefully, one thing does become obvious: Most of the time, the peaks and the valleys move in tandem for all the currencies. I must assume, and it can be verified in another exercise, that when they differ, it is when interest rates in the country of the currency in question has been increased. An interest rate increase has the effect of strengthening the currency compared to the others. However, as the chart shows, they very soon fall back into the pattern.

Based on this premise, I feel justified in using the Canadian dollar to forecast the future movements of the US dollar. The United States is Canada's biggest trading partner, and an overly strong Canadian dollar will make Canadian merchandise too expensive in the US, seriously affecting the Canadian economy. This has become a fact, as Canada appears to have stopped increasing rates in an effort to keep its currency weak.

Figure 2 is a chart of the Canadian dollar only, showing an Elliott wave count. With it I offer a number of scenarios about the possible future movement of the Canadian dollar (or the US dollar, for that matter).

Figure 2: Canadian dollar

The wave count is not the easiest, and it is very open to correction as events change. My preferred wave count is a variation not found in the text. It states that "if wave three is less than wave one, then wave five must be less than wave three."

I am prepared to consider this variation as my preferred count at the moment, because I find it difficult to accept that the US dollar will be allowed to weaken dramatically. And parity with the Canadian dollar will not be to Canada's advantage.

Figure 2 shows two possible targets (green). The one (0.932) is my target, should wave 4 complete at present levels (0.801), and my second target is 0.90, should wave four only turn upward from the trendline support. The former is preferable because of the wave rule:
"Wave 4 shall not fall below the top of wave 1."

Should wave 4 indeed fall to test the support line, and in doing so, fall below the high of wave 3, I will have to reconsider my wave count.

I have shown on the chart that should the Canadian dollar find the support level of 0.786, the top of wave 1, it will do so on June 10. The relative strength index (RSI) is suggesting this possibility, as it has not yet fallen below the 30 level, but has "kissed" it. It has broken above the three-period moving average (green) and is touching the seven-period moving average (red).

To conclude, the US dollar, based on the evaluation of the Canadian dollar, is approaching a major turning point and should start weakening once again. Wave count theory places a target at 0.90 and 0.932 to the Canadian dollar, which means that the US dollar could possibly weaken a further 17%.

Koos van der Merwe

Has been a technical analyst since 1969, and has worked as a futures and options trader with First Financial Futures in Johannesburg, South Africa.

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Forecasting The US Dollar

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