Bear Hunting In The Canadian Currency

04/16/07 09:06:47 AM

by David Penn

Looking for a long-term bear market that's showing signs of reversal? Try the USD/CAD currency pair.

Security: USDCAD
Position: N/A

One of the most interesting — or haunting — things I've ever read about the markets came from international money manager Marc Faber. Faber observed that if you made a single investment decision at the beginning of each of the past few decades — and maintained that investment throughout the decade — you could have made a tremendous amount of money on a number of markets that had been virtually left for dead.

FIGURE 1: US DOLLAR/CANADIAN DOLLAR, MONTHLY. The bear market in the USD/CAD has seen the greenback lose more than 30% against the "loonie," as the Canadian dollar is colloquially called, since early 2002. The series of shallower troughs in the weekly MACD histogram beginning in 2004 suggests that momentum to the downside is gradually waning as the Canadian dollar moves closer toward par with the US dollar.

Graphic provided by: eSignal.

In summary, Faber observed that if you had bought gold in 1970, held it for 10 years, then sold it and bought Japanese stocks, held them for 10 years, sold them, then bought American stocks (especially tech stocks), held them for 10 years and then sold them, you would have pretty much taken maximum advantage of some of the strongest investment trends of the past 30-plus years with relatively little effort (aside, perhaps, for the exceptional prescience such investment might have required).

This sort of thing occasionally has me looking at long-term, multiyear charts for the kind of jumbotron bear markets that can create real bargains for investors willing to forage through the rubble. With my recent attention to the foreign exchange markets, one such supersized bear market appears to be the market for buying US dollars and selling Canadian dollars, as expressed by the charts of the USD/CAD currency pair.

It would be hard to equivocate the bearishness of the USD/CAD pair. Although the USD/CAD ended 2006 roughly flat to up slightly, it is not at all unfair to suggest that, on balance, the greenback has been falling against the loonie for five years running (Figure 1). The question is whether the current bounce, which began with the summer of 2006 lows, represents the beginning of the end of that five-year bear market, or if it is merely a pause in the midst of a bear market that has yet to run its course.

For the bottom-feeders, the best reason for bullishness lies in the positive divergences that have been developing between the price of USD/CAD and the moving average convergence/divergence (MACD) histogram (Figure 2). These positive divergences began in late 2004 (that is, the first, positive MACD histogram divergence in the monthly chart was between the trough in 2003 and the trough in late 2004) and are clear in both weekly and monthly chart views of USD/CAD.

FIGURE 2: US DOLLAR/CANADIAN DOLLAR, DAILY. Positive divergences build as the USD/CAD moves lower, correcting the bounce from the second half of 2006 (see Figure 1).

Graphic provided by: eSignal.

Along those lines, the MACD histogram provides another potential clue. The size of the MACD histogram peak during the bounce that began in the second half of 2006 was larger — and by a wide margin — than any of the peaks that accompanied previous bounces during the 2002–06 decline. As I wrote for Working Money years ago, the MACD histogram peaks of this sort can often be predictive of a market bottom and reversal to the upside (see my "Post-Breakdown MACDH Extremes," May 19, 2004).

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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