Commodity-Centric Currencies Slide

From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley

As we near the close of another month, crude oil is once again front and center.

At the end of October, black gold was ripping to new seven-year highs while interest rates rose and cyclical stocks kicked back into gear. 

Today, this picture has dramatically changed. 

Crude oil is currently about 20% off its highs, as prices have collapsed back below our risk level.

Crude dropped $10 during last Friday’s volatile session and continues to slide lower this week. Just look at this bearish candlestick on the monthly chart:

Not only is this an ominous candlestick formation. It's also occurring at a key level of interest at the multi-year highs from 2018. This failed breakout is setting up nicely for a fast reaction to the downside. 

Most commodities were already in consolidation phases ahead of the recent sell-off. Now the entire asset class is on the ropes.

When we look at the bond market, interest rates continue to chop sideways, treasury spreads are falling, and credit spreads have just recently started to tick higher.

As for any clues from the stock market, there isn’t much for the bulls there, either. Cyclical stocks have fallen back into their former ranges, while small- and mid-caps failed to hold their recent breakouts.

Bottom line: The subtle risk-off tone that led us into Q4 has reemerged.

What are currency markets telling us about these developments? Let’s turn back to crude oil for some answers.

A month ago, we asked if currencies would confirm the rally in crude. At the time, our petrocurrency index was not printing new highs along with the energy bellwether. 

Here's what the chart looked like then.

And here’s what the chart looks like now:

The lack of confirmation from petrocurrencies turned out to be a great indication of the future direction of crude. 

Not only did our petrocurrency index never make a new high and confirm the action from crude; the index is already making new lows just one month later. 

When we zoom in for a closer look, the warning sign becomes clear:

Our index produced a negative divergence by making lower highs while crude oil futures made higher highs, tipping us off that the rally was unsupported. Also, notice that our index has led at significant junctures since last year’s historic sell-off in crude.

All of this adds to our conviction that the petrocurrency index acts as a potential leading indicator of crude oil prices. It demands our attention going forward.

In addition to carrying intermarket implications, the above index reveals the weakness among commodity-centric currencies.

While the Australian dollar may not be in our petrocurrency index, it’s one of the essential commodity currencies in the world. And it’s on the verge of losing a crucial level of former support:

The AUD/USD looks like it’s carving out a massive top as it tests its year-to-date lows and the breakout level of a multi-month distribution pattern.

We want to sell weakness on a break below 0.7106 with a downside measured move around 0.6200 over the next 2-4 months. 

If we’re shorting one of the world’s leading commodity-centric currencies, what does that tell us? 

It probably means commodities (and risk assets in general) are still under pressure. The bears earn a point as this pattern confirms and breaks to the downside.  

We’ll keep a watchful eye on the Aussie as well as our petrocurrency index for hints of further weakness.

Stay tuned!

Thanks for reading. As always, let us know what you think.

And be sure to download this week’s Currency Report!