For the past 10 months the US Dollar Index ($DXY) has been steadily weakening, dipping to 91 in September. This is a far cry from the Greenback’s trumped-up highs of 104 in early 2017. However, the charts suggest the Dollar might now have found a floor and is preparing to move higher. What might this mean for commodity prices?
A key part of technically analysing a price chart is looking for the ‘set pieces’; recognisable patterns that more often than not prove to be key indicators in price movement. One such set piece is the bearish ‘Head & Shoulders’ pattern (indicating a market top) or its bullish counterpart, the ‘Inverse Head & Shoulders’ (indicating a market bottom).
Looking at the US Dollar Index daily chart, I see an Inverse Head & Shoulders pattern that has been forming since August. Now, according to technical analysis folklore, what is likely to happen is a reversal of the downtrend. Usually traders will enter a position around what is referred to as the ‘Neckline’ of this pattern (around 93.75 in this case), and will set a cautionary stop loss just below that level. The target price to take profit is usually the height of the pattern added above the neckline i.e. the distance from the neckline to the head of the pattern. I calculate this to be around 96.21 for $DXY.
With the USD at the heart of our financial Universe, a reversal in Dollar strength reaches far beyond the world of Forex. One key sector that I am particularly interested in is commodities. The weakening of the Dollar during 2017 certainly contributed to the rally in commodity prices. Although it’s by no means a direct correlation in the short-term, the comparative charts show clear evidence of longer term divergent moves in Dollar strength versus commodity weakness. There is every chance now that this recently-formed pattern might signal a potential stall and reversal of the commodities rally. If the US Dollar Index breaks upward I suggest it will trigger a sell off of the commodities sector.
Yellow and Black Gold
Gold futures have already slumped back after what seemed like an invincible bullish charge during July to September. The price peaked at $1361 and has already retraced to a current support level of $1275. A recovery in the Dollar will inevitably break down Gold’s recent bullish moves.
Another commodity that has seen a recent positive charge is Oil. Whilst the Dollar has a strong effect on Oil price movements, there are many other factors in play. Supply and demand is key, and the building glut of stored oil over the past few years was the main factor for its epic price collapse. There is however strong evidence that the market is rebalancing; OPEC production restraints, uneconomic oil producers failing, and a little Mother Nature throwing a Hurricane or three into the mix, have all assisted Brent to almost hit $60 a barrel on 2 occasions this year.
Will a strong move in the Dollar stunt oils recovery? I propose it will cause a retrace, but I’m bullish in oil, there are too many ongoing factors that suggest oil supply is going to tighten further, the biggest being the lack of investment in the industry in recent years.
The Commodities Recovery
Commodity prices have had an exceptional run on the road to recovery in recent years after hitting industry-devastating lows at the beginning of 2016. Investors in headline companies such as Glencore (LSE:GLEN), Anglo American (LSE:AAL) and BHP Billiton (LSE:BLT) have seen as much as 500% gains in the past 18-24 months. This has been an incredible move for such large stocks.
Whilst there is still potentially much ground to make up in the commodities sector, perhaps it is time for shareholders to review their positions and take profit soon.
Spotting an early warning signal that might indicate a reversal of a trend is indispensable information, and I believe the US Dollar Index chart is flashing red for commodities.