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Imminent top in the dollar

For anyone who’s been in possession of the world’s reserve currency, 2014 has been an awesome year!  Since bottoming out near the 79 handle in early May, the dollar has staged a relentless 8-month rally.  Some of the big fundamental storylines that contributed to the relentless surge in the US dollar index were weakening economic data from the Eurozone, the collapse of the Japanese Yen due to Japan’s extreme (and verifiably insane) monetary policies, and general geopolitical developments concerning regional instability in places like Ukraine and Iraq.  All of these precarious developments served to send capital from around the world rushing into the U.S. dollar due to its perceived status as a safe-haven.   Recently however, the dollar has been signaling that the strong bull trend that has characterized much of the past year is reaching a point of exhaustion.

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As the above chart shows, the US Dollar Index has recently encountered long term resistance in the 89.63 area dating back to March of 2009.  The dollar has initially backed off upon reaching this area 3 days ago.  Additionally, there is a secondary long term resistance level 3 handles higher at 92. 63 which dates all the way back to November of 2005.   If the dollar is able to break through the 89.63, the 92.63 would most likely cap any additional gains.  From a very long-term macro-view, GeoFront Capital believes an eventual retest of the 120 area is possible, but the dollar first needs to catch its breath here in the short term

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Drilling down onto the daily chart, the 2014 rally is prominent displayed.  As shown, it is possible to count a completed 5 wave Elliott-wave-sequence which began back in early May.  Since Elliott wave theory is fractal in nature, these 5 waves are together the first initial wave of an even larger wave sequence.  According to the Elliott wave model, once 5 waves are complete, a corrective retracement of the previous wave will commence.  Wave 2 will be a partial downwards retracement and will likely bring prices back to at least the 84.50 area which is the “previous 4th wave of one lesser degree” which is a common location for waves to retrace.  Additionally the 50% fibonacci retracement level resides in this area as well, making it a compelling target zone.

The Relative Strength Index, which indicates price momentum, is showing what is referred to as a bearish divergence.  The price of the US dollar index has continued to make higher highs, but the RSI has been registering a series of lower highs since September, with each high since then registering lower the previous one.  This says that the advance has grown tired and is due for a reversal.  Another item of note is the fact that the RSI chart itself is getting close to breaking its own upward sloping support line. Breaks of this kind on RSI charts can be indicative of significant trend reversals, and should be taken into consideration, especially when the RSI support line is well defined like it is here.

So how and more importantly when, will we know for sure that the US dollar index has topped?  Well, when analyzing the USDX, it is important to know that the USDX itself is composed of nothing more of a basket of difference currencies.  Knowing what these currencies are, how they are weighted inside the index, and where they are trending can provide solid clues to the future direction of the USDX.  The Euro accounts for a 57% weighting. Over half of the index is tied to this one currency!  So, it behooves savvy currency traders to look closely at the Euro to get an idea of where the dollar is likely headed.  Now let’s take a look at what the EURUSD has been doing lately.

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Unsurprisingly, this chart is almost an exact mirror opposite of the USDX.  The EURUSD pair has been in a severe downtrend since early May of this year.  It has also completed a 5 wave Elliott Wave sequence and it is already showing signs of having put in a potential bottom.  Contrary to the USDX which is showing a BEARISH divergence, the EURUSD pair is showcasing a textbook BULLISH divergence.  This is a strong warning that the lower lows the pair has been making since September should be considered suspicious because they have gone unconfirmed by momentum. Furthermore, it is probable that this entire stretch from September will be fully retraced which would amount to a 50% upward Fibonacci retracement of the previous 8 month decline. Additionally, RSI looks like it is breaking through its downward sloping resistance line.

Finally, speaking of downward sloping resistance lines, EURUSD is sporting a very, VERY, well defined downward sloping resistance line dating back to the 15th of October.  Even though it is drawn on the chart, it is important to keep in mind that we at GFC did not draw this line, the market did. This resistance line has 6 separate touch points.  This many touch points dramatically increases the validity and the implications of what this line portends.  A solid daily close above this line today would provide strong confirmation that the downtrend has ended and a substantial upward retracement has begun. One should expect additional upward follow through in the weeks ahead.  To conclude, it is extremely like that U.S. dollar index is topping at this specific juncture.   The recent price action in the foreign exchange markets is signaling a significant trend reversal that will consequentially produce a tailwind for bullish price behavior in the precious metals.  If you haven’t seen GFC’s latest analysis on Gold,  be sure to check out “A Nice Time to Be Bullish on Gold” now.

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Phil Olson has been a devoted student of the financial markets since childhood. With over ten years worth of experience trading various investment products, he has developed an insightful way of discerning the price behavior of the market. His trading career took off when he proved to be on the correct side of the 2008 financial crisis by shorting stocks such as Lehman Brothers, Fannie Mae, and Freddie Mac. Since 2009, after capitalizing on the crisis-driven downdraft in financial stocks, he turned his attention to the foreign exchange market and became a successful currency trader. His extensive educational background in the areas of business and finance has afforded him the benefit of being able to apply two types of analysis (Technical & Fundamental) simultaneously to the market in order to identify high-probability trade opportunities. With his distinct and complementary approach to navigating the investment landscape, Phil became a trusted source for financial advice among his family, friends, and co-workers. Prior to partnering with Matthew to create GeoFront Capital, Phil Served as a Captain in the United States Air Force as a Contracting Officer responsible for authorizing, writing, and administering multi-billion-dollar contracts between the Air Force and the Aerospace Defense Industry. His successful experiences in handling large amounts of fiduciary responsibility on behalf of both Congress and the American tax-payer lend themselves well to the financial advisory services of GeoFront Capital.

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