Jan. 14 (Bloomberg) – Canada’s dollar fell to the lowest level in a month as the U.S. dollar strengthened against most currencies, boosted by investors seeking a haven against a deteriorating global economy.
Jan. 14 (Bloomberg) – Copper prices dropped after the government said U.S. retail sales extended a slump to the longest in at least 16 years, signaling the U.S. recession is deepening and metals demand will decline.
The Canadian dollar (CAD) is often referred to as a ‘commodity currency’ because it tends to trend higher and lower with commodity prices. The same would likely be true for the South African rand, Brazilian real, Mexican peso, and New Zealand dollar but we tend to focus on the Canadian and Australian dollars when we are discussing the link between the forex markets and commodity prices.
To start things off today we are going to show two chart comparisons between the Canadian dollar (CAD) futures and the S&P 500 Index (SPX). The chartbelow is from the time period extending from the autumn of 1981 into January of 1983 while the otherchart below covers the time frame from early 1998 into May of 1999.
The Canadian dollar trends with commodity prices and, at times, the equity market is driven by the trend in the commodity markets. When the trend for commodity prices is viewed as important for the equity markets then it makes sense to pay attention to action in the commodity currencies.
Why? Because as long as the Cdn dollar is making new lows there will be downward pressure on the equities of the commodity producers which will, in turn, add pressure to the broad stock market. Another very good reason would be that in these kinds of cycles the Cdn dollar has shown a tendency to bottom and start to rally a month or two ahead of the SPX.
The point is that as long as the Cdn dollar is weaker one has to remain somewhat negative with regard to the equity markets. Our sense is that if we put together a chart of the S&P 500 Index times the Cdn dollar we might find it useful in our attempts to ‘find the bottom’ later this year.
Equity/Bond Markets
Over the past week or two we have focused rather intently on trying to build our argument that we believe that the Canadian and Australian dollars are going to move to new lows this year. In other words we have been constructing a thesis that includes substantial downward pressure on the U.S. equity markets. Our problem is that while we are aware that we are making an equity ‘negative’ argument we really aren’t that negative on the U.S. equity markets. More on this in a moment.
Belowwe show the CAD futures and the SPX from the current time period. Notice that the CAD made a bottom in October which preceded (by the requisite ‘month or two’) the November lows for the SPX. In other words if the U.S. dollar peaked last autumn and the Cdn dollar bottomed then it made perfect sense for the equity markets to rally- as they did through late December and into early January- based on a return to strength in the commodity cyclicals (i.e. oils, mines, basic materials, etc.). If we could not make a case for the Cdn dollar moving to new lows then we had to abandon our ‘consumer defensive and health care’ stance and get positive- quickly- on the commodity and financial cyclicals.
Now… in search of a point… we are going to digress once again as we attempt to explain why it is that we really aren’t that negative with respect to the large cap U.S. equity indices.
First, the chart below compares the SPX with the product of the U.S. 30-year T-Bond futures times the CRB Index. The argument is that the equity markets- similar to 1982- are being driven lower by the commodity markets while being supported by the bond market. As long as the CRB Index times TBonds combination of moving sideways the trend for the SPX should be relatively neutral.
Second, the U.S. large cap consumer and health care stocks serve as the anchor for global equities. When the dollar rises and there is downward pressure on commodity prices the U.S. large caps should outperform virtually ‘everything else’. If the major U.S. equity indices continue to decline at a rapid pace then ‘everything else’ is going to do even worse and given our view that the world is actually NOT coming to an end we tend to favor of more neutral outcome for the SPX and DJII.
