Early Birds and the Forex Journal-Currencies for Q3&4 2013

Learned tomes of which Forex Journal is an undoubted leader provide many functions. The best educate, teach, enliven and inform. These are processes of reward and enrichment of the brain, spirit and soul. In some cases that enrichment can even go straight to your pocket, a much underestimated part of the metaphysical anatomy which, for traders is closely aligned with the heart. All of you know the joy and sense of wellbeing that a great trade brings. Happiness, delight; for some sheer relief. All emotions that boost health, self-esteem and of course wealth, and likely lower your cholesterol and blood pressure as well, conditions much ignored by our younger readers but nonetheless pervasive killers stalking the unwary.

The very best antidote to the slings and arrows of outrageous fortune which beset our everyday lives and traders' lives in particular, are well plotted, superbly executed and highly valuable winning trades. This is a story of one such adventure.

It starts in December 2012 when the publisher of this august magazine wrote to ask me to opine on the best currency trades of 2013, a great pipe opener for the year and if analysed correctly, a boon for currency traders looking to start the year with a flourish. For me, a dweller in the lands Down Under (Australia and New Zealand), this was a no brainer as I live every day with the tyranny of the most overvalued currencies on the planet, the Aussie and Kiwi Dollars (AUD and NZD). Thus, in the fullness of time, my article "The Words that Dare Not be Spoke Down Under!-The Best Currency Trades for 2013" appeared in the February edition of Forex Journal, where I told you that the best trade of 2013 was going to be short the AUD against all of its major trading partners USD, EUR and JPY. I didn't fail to show you that the Aussie and Kiwi currencies are joined at the hip due to Australia's position as New Zealand's major trading partner and the trading band that CER (Closer Economic Relations) legislation and usage imposes. Hence, you were armed at the start of the year with a bag full of options. Two currencies whose fundamentals were systemically at risk and several different possible strategies. Property values, Treasury tax receipts and Stock Markets are just the flag bearers of important socio-economic functions that are merrily reported by local news media without regard to the reality of currencies at the cross rates, but ignorance of how currencies link all aspects of your life is injurious to your financial health as we shall briefly examine.

To bring you up to date, I said in my previous article that the week around February 14 would be an important inflection point for AUD, but I reckoned without Mr Abe's ambitious "3 Arrows" plan to break Japan from its endless deflationary cycle. This from a speech he gave on 02/22/13:

"As the first arrow, I urged the Bank of Japan to do their job, on a dimension they thought they couldn't do. Investors, both Japanese and foreign, have started to buy Japanese shares. Japan's industrial wheels are better greased due to export growth, and Tokyo's stock index has risen as a result. The second arrow is to carry out a supplementary budget, huge enough to lift the economy by 2 per cent and create 600,000 jobs. The third one is about growth strategy. Private consumption and investment will come much sooner than we expected. So far, all the economic indicators point north."

This ambitious and unprecedented stimulus sent JPY ballistic on the cross rates and nowhere more obviously than in AUD-JPY. Mrs Watanabe, the mythical Japanese housewife investor has been a mainstay of Australian capital raising for decades, as she arbitraged the traditionally high interest rates on offer from a generous Australian Treasury against the ZIRP options so long prevalent in her homeland. The euphoria caused by this announcement sent AUD-JPY into orbit as with the exchange risk hopefully neutralised, this on-going favourite for the carry trade appeared to become an even stronger one way bet. As usual, the market had well anticipated this policy. Here's the chart:

There are three points of interest on this chart which you may not be familiar with. The chart is a 12 day timing chart. Our base timing chart is a 6 trading day chart, that is each bar is composed of 6 trading days or in this case 12 trading days. The timing cycles along the top of the chart are the dominant Danielcode 59 cycle which traditionally marks tops and its next iteration 2X59. Running from the high of the rally at 11/2007 we get exactly 2 periods of the 59 cycle expiring in the 12 day period ending 04/08/13, and that gave us the closing high for the move. All chart analysis is valid from bar high/lows and also from closing highs and lows. Hence the DC time analysis is often variable by +/- 1 bar period.

The red line drawn on the chart is the 4^th Degree line. Price or the vertical axis of charts is the 1^st Degree; Time or the horizontal axis of charts is the 2^nd Degree; Volume is the 3^rd Degree and the 4^th Degree is an angle combining time and price. There are many angles applicable to charts. Some provide simple support and resistance, others project future trading channels. All are useful. But the most useful of all are the 4^th Degree lines which have a set of formal rules for their construction. In many respects they act as support and resistance but have the peculiar and valuable additional quality that we expect to see price meet the 4^th Degree line at major DC time cycles. When this conjunction of time and price occurs we say that "Time and Price are Squared", and when time and price are squared a turn in market direction is almost inevitable.

Gnostics ("those who know" from the Latin Gnostici) call this conjunction The 4^th Seal. It is one of the miracles of the Danielcode.

Whilst the 4^th Degree adopts a lateral view of charts in that it combines time and price with its angles and time cycles, we must not fail to apply our simple linear analysis. The Danielcode uses a series of proprietary ratios unlike any others you have seen, although 2 of the 7 DC ratios are close to the more traditional fibonnaci ratios, but don't confuse them. The DC ratios spring from a wholly different mathematical paradigm. Potent amonst these ratios is the now famous Danielcode Black line at 89%, the last level of support or resistance for the operating swing on all charts. Markets are notorious time shifters and what is not apparent on one time series may be a shining light on another. Our rules of analysis require that we consider 6, 12 and 24 day charts and adding our DC ratios to the 24 day chart, this time a close only chart shows that not even the most ambitious fiscal intervention could overcome this mark:

Thus in early April 2013 we had strong evidence from the 4^th Seal, DC time cycles and the DC retracement tool to expect at least a meaningful correction in this currency pair, the most important driver of the ubiquitous Yen carry trade. It's now down over 14% from the recent high.

Carry trades have two elements of risk and reward. The exchange rate at time of maturity and the interest differential. The latter is a function of government policy and as a consistent borrower of overseas capital Australia has run official interest rates 3-4 points above its major trading partners, US, Japan and Europe. Not coincidentally these are also its major lenders. As Down Under manufacturers and other export businesses other than mining have suffered under the ravages of the high Aussie and Kiwi Dollars, including Ford Australia shuttering its 85 year old car making business in Victoria, few have publicly argued that this AUD strength is a direct result of government and Reserve Bank policy. Apparently the needs of government to fund its always expanding political largess trumps all other considerations.

The Melbourne Age newspaper provides a concise summary of the Aussie Dollar's imminent demise:

..the high dollar has made Australian producers dramatically less competitive in global and domestic markets. The International Monetary Fund estimates that it costs 55 per cent more to produce goods and services here than it does in the US. The miracle is not that manufacturers such as Ford are pulling out, but that so many have found ways to survive. But, once they go, they won't return. The overvaluation of the dollar is temporary, but it changes the economy permanently.

The mining boom has peaked, and is now declining. The greatest risk we face is that the weakening economy will fail to develop the momentum to leap the gap left by declining mining investment. If we fail, it won't be because interest rates are too high, but because the dollar is too high. To cut to the chase, the Reserve faces the choice between risking recession or risking inflation. One way or another, by policy choice or market pressure, the dollar is going to fall a lot ahead, as mining investment subsides, and - you hope - the global economy finally gets its mojo back. That will make our producers competitive again; it's what we want to happen. But it will have unpleasant side-effects. A lot of things we now take for granted will become more expensive, maybe much more expensive. The holiday in Europe we were planning could cost 20 per cent more, and become unaffordable. Petrol will be much more expensive. So will all the imports we buy: cars, computers, mobile phones, household goods, food and clothes.

Until now, the high dollar has made the Reserve Bank's job easy by making imported goods cheaper. When the dollar falls, they will become more expensive, and inflation could rise well above the Reserve's target zone of 2 to 3 per cent.

So to return to the theme of this article, let's look at where the AUD-USD pair is now and what the future has in store with our 6 day timing chart:

Again our dominant 59 DC time cycle called the top near 08/2011. This was the 2^nd iteration of this time cycle, valid as our rules say "it shall be for time, times and an half", and the twice 59 cycle gave us the chart high at the spike in the 6 day period ended 08/2011. Looking at our 4^th Degree angles we have on the above chart 2 rising angles, one emanating from the 10/2008 low and the other from the low before the low. The latter line gave us the momentum high near 05/11 whilst the former gave us the chart high 3 months later. If you noted that the high projected by the upper of the two near parallel lines gave us the momentum (closing) high but then a benign 7 week counter trend whilst the lower red line drawn from the 10/28 low gave us a significant trend change, then you are on to the difference between a 4^th Degree line and the 4^th Seal. The conjunction of the 4^th Degree line with an expiring DC time cycle is what made a trend change after 08/2011 almost inevitable.

Another way of looking at charts in the lateral plane is by using DC trading channels. These are basically regression channels using the DC ratios. For transparency and the benefit of those interested in market timing, you can read how, in the two "Master Class" articles at my website www.thedanielcode.com and there are detailed videos there also on constructing and reading DC trading channels.

Let's start with the major time frame and work back to complete our analysis of where this currency pair is headed. As the short AUD and NZD theme has worked so well for us in the first half of the year, I suggest we stick with it in the latter half as both of these currencies have much further to go on their corrective path

There are two valid DC trading channels on the above chart. The channel in blue is the long term trading channel running from 2001 whilst the red channel starts in 11/2008. Note that this market has found support at the 1SD of the blue channel and the 2SD of the red channel and the DC retracement at 92.92. This is neither a miraculous occurrence nor happenstance. This is what markets do all of the time. From this strong support we expect a rally before AUD-USD resumes its downward path. It has a date with destiny at the 2SD of the blue DC trading channel near 86.56 by November this year.

Here's the current move on the daily chart bottoming for now at the "heathen" 70 cycle which we more traditionally associate with Euro time cycles, and at 3SD from its DC mean.

There is still much to play for on the short side.

Spend a moment reflecting on what the present 14% decline in the Aussie means in this country where private debt ranks near the highest in the world and where housing prices are also world leaders. And consider the words of Reserve Bank Governor Glen Stevens for context:

"Central banks can provide liquidity to shore up financial stability and they can buy time for borrowers to adjust, but they cannot, in the end, put government finances on a sustainable course. They cannot shield people from the implications of having mis-assessed their own lifetime budget constraints and therefore having consumed too much." Glen Stevens, Governor of the Reserve Bank of Australia"

Things are getting interesting!!

John Needham

Sydney Australia

jneedham@thedanielcode.com

www.thedanielcode.com

19 June 2013

"The fox knows many things, but the hedgehog knows one big thing. A Hedgehog Concept is not a goal, intention or strategy to be the best. It is an understanding of what you can be best at. The distinction is absolutely crucial". ~ Isaiah Berlin, The Hedgehog and the Fox