The Greenback and the CRB

01/11/02 12:06:39 PM

by David Penn

What are dollars and commodities saying about inflation and economic recovery in 2002?

Security: DXY, CRB
Position: N/A

One of the tenets of intermarket technical analysis is that given that a falling dollar is inflationary, inflation is an observable market phenomena when commodities bottom and begin to move higher. I note this because recoveries from economic recessions tend to involve some measure of "inflating" the economy through additional liquidity to the economic system--whether from tax cuts, monetary policy, government spending, credit expansion or a combination of all the above. Thus, those looking for signs of an economic recovery in 2002 may do well to study the recent price action of the U.S. dollar as well as the CRB index of commodities.

The greenback made a bottom in September 2001 as part of a diamond bottom reversal pattern I noted back in October ("The December Dollar's Diamond Bottom: Pullback or Failure?"). This was a higher intermediate low, compared to the previous significant low in January 2001, which confirms that the dollar's uptrend since 2001 remain intact (the greenback's bull market actually extends as far back as October 1998). While a continued uptrend would necessitate the eventual taking out of the current greenback high of 120 from July 2001, it is reasonable to assume that the uptrend is in place for the time being.

An uncharacteristic period in which the CRB and the greenback move in tandem may be ending should the CRB run into resistance at an old support area.

Graphic provided by: MetaStock.

A few weeks after the greenback bottom in September, commodities appeared to end their bear market--which began in January 2001. The commodities bottom in October set the stage for a commodities rally--which has continued into 2002; the CRB Index has appreciated some 7% from October 2001 to January 2002. It is this bottoming and upward movement of the CRB Index that has some suspecting that a measure of recession-fighting inflation has moved into the market, and that the subsequent higher prices will help restore some profitability to a variety of companies, thus fostering the much-anticipated 2002 recovery.

The continued strength of the dollar looks likely to keep commodities from appreciating too quickly, however. Whatever mildly inflationary signals are given off by rebounding commodities' prices are largely countered by the bullishness of the greenback. Generally speaking, commodities and the dollar move inversely, with stronger dollars keeping commodities prices low and weaker dollars making commodities more expensive. This is true generally; there are periods in which both the dollar and commodities are trending downward--such as July to September 2001. But it should be remembered that in that period of "fellow traveling," for example, the greenback was in a correction mode from a previous rally (January to July 2001) during a bull trend. At the same time, the CRB Index was in a slow-motion free-fall during the entire period.

As such, the inverse relationship between commodities and the dollar refers most accurately to the primary or long-term trend. What this also means is that shorter, intermediate instances in which commodities and the dollar are traveling in the same direction tend to be unstable, with either the greenback or commodities likely to revert to their inverse relationship. One technical way to attempt to detect when this "reversion" is likely to occur is by looking to see what sort of resistance to a continued upward move exists. In the present case, both the greenback and the CRB have appreciated by about the same amount since putting in their respective bottoms (between 4% and 6%). Still, the greenback has recently pulled back to its four-month upward trendline, put in another higher low, and now looks to be headed toward a retest of the 30-day high at 118. On the other hand, the CRB Index is quickly moving toward a resistance area created by the lows from the summer of 2001. In order for the CRB's uptrend to remain intact, taking out resistance at about 197 is a major task ahead.

David Penn

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

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TECHNICAL ANALYSIS

The Greenback and the CRB

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