Is The British Pound About to Significantly Weaken?
Before I begin, I hope everyone in the United States enjoyed a happy, healthy, and festive Memorial Day weekend in memory of those who sacrifice so we may enjoy the freedoms that we do.
Now I’m going to cover several FX pairs today, including a surprising change of stance on one pair I’ve been talking about for a long time. I’ll also discuss the precious metals, the NASDAQ, and an ETF I haven’t mentioned before.
So let’s get started with the US Dollar Index (USDI):
The USDI measures the US dollar against half a dozen of the major and most liquid currency pairs. As you can see, it’s been locked up in a trading range market for the last six weeks or so. Quite frankly, I wouldn't be surprised to see the back and forth conditions persist for a while longer as USDI has a previous history of this behavior.
That doesn’t mean there will be no opportunities, but I typically approach the summer season by assuming there’s a much-reduced likelihood of clear breakouts from one level to another.
As regular readers know, I'm not in this game to take 20 or 30 pips out of the market. I'm always looking for a major breakout from one level to the other for consistent long-term profits. You can’t enjoy long-term success by being in and out of the market five or 10 times a day.
A good opportunity is one that offers a few hundred pips of potential, but unfortunately you have to be a bit more realistic in the summer due to reduced volatility. For the record, I've made extraordinary games earlier this year including 900 pips in a single move in USDJPY and 1,200 pips in GBPNZD. But right now in these summer months, you have to be realistic.
Realism starts with a long-term view at the weekly chart level (where each bar represents one week in time) so you can understand what's going on, including the trend or pattern that’s driving the underlying market.
So let’s discuss a few pairs that meet those criteria, starting with GBPJPY (the British pound versus the Japanese yen):
Although GBPJPY has been range-bound recently (and this could continue for awhile), when you take a long-range view you see this chart is ultimately very bearish. There are numerous bearish patterns here, which strongly suggests this market will be going lower over time.
The first pattern was the very pronounced double top which formed the head of a head and shoulders. This is a reversal pattern. You can see that the market was ascending before this pattern and then descended after the price broke through the neckline at the 175 area.
Since then GBPJPY has established a bearish rounding top marked by a complex head and shoulders. A ‘complex’ head and shoulders has multiple shoulders on each side of the head.
GBPJPY had a little bounce recently off its long-term support line, but to me this is a dead cat bounce. I don't think it will last and we'll see another new low in this pair sooner or later.
That’s why I’m looking for opportunities to short GBPJPY on any rally. What’s more, I’m planning to hold my short positions for what could be a considerable period of time. Sometimes the market does go through these phases where you have to be patient until things resolve as anticipated.
Remember, nobody rings a bell when the trading conditions are good and it's ready to go. That’s why I’m happy to short any rallies in GBPJPY, add to my short position as opportunities arise, and wait for this pair to test the 125 level (and perhaps even lower) later this year.
Now here’s GBPNZD (the British pound versus the New Zealand dollar):
It looks like the British pound is starting to significantly weaken across the board against the major currencies now. Including NZD!
That’s after me saying for the last couple of years that GBPNZD would continue to rally based on the bullish double bottom it established. GBPNZD did in fact traverse much higher from the low of 1.65 to a high of about 2.18.
However, it looks like that rally might be finished for GBPNZD for the foreseeable future.
That’s primarily due to the blowoff top (also called an exhaustion top) where the price rose very strongly to establish multi-year highs only to close out the week near a low. This was a very large range bar from the high to the low (about 1,800 pips in one week). By closing at or near the low, this bar became a key reversal that points to lower prices.
This is ominous because GBPNZD did something similar several years back as I’ve noted on the chart. You can see how the price behaved after that first exhaustion top formed. So I believe the current example could foretell a similar downward trajectory, especially with the mini rounding top that’s just appeared.
There’s also the fact that GBPNZD has broken out of an upward-trending channel and closed at the low for last week. I think this bearish price action could open up another move much lower.
Of course, this is summer trading so this pair could enter a trading range first.
But don’t rush in with a short just yet. Remember that the summer season is upon us and things move more slowly now.
Personally, I’m going to try and enter with a sell limit order a bit higher than the current price to catch any rally that might occur.
However, be warned that the problem with a limit order is that even if I'm right and the market rises, it may not catch my limit order before rolling over and dropping. So I'm alert for opportunistic GBPNZD price action, particularly on the daily chart.
To add to the continuing bear case for the British pound, here’s GBPAUD (the British pound versus the Australian dollar):
A few weeks ago I suggested you get short this pair based on the breakdown from the ascending broadening price formation on the chart.
It’s called an ascending broadening formation because it starts narrow and then broadens at the top, as you can see. When the price breaks down from such a pattern, it usually goes all the way to the base of the pattern which in this case is the 1.17 area.
So far, GBPAUD has done nothing but drop since that breakdown. But there are still several hundred pips to fall to the target price. When it gets there is somewhat of an unknown, but I would be alert for any rally to get on board as I think that GBPAUD is going to hit that target sooner or later.
The main risk is that even though we see a clear objective, GBPAUD could tread some water before dropping. Take a longer-term view during the summer and use lower risk and wider stops. These are challenging market conditions and you’ll preserve your emotional and financial well being if you keep that long-term perspective going forward.
Let’s look at XAGUSD (spot silver) now:
For the past five or six years, silver has operated within the boundaries of a large descending triangle marked by lower highs and a common low at $14.
At the moment, silver’s on a trajectory to pierce the upside of that triangle. However, it hasn't done so yet and it's quite possible that silver could still slump back and trade sideways for a while.
However, I’m looking at this with the view of a bear trap having been established below $14. You can see the market penetrated below the $14 floor and triggered a lot of short sales all at once.
It seems a number of speculators had sell stops in below $14, but silver has bounced right back into its regular trading range. That means those shorts are trapped. This situation can often set the table for an opposing price reaction, but for that to happen, we need to see silver setting new multi-year highs above $19.50 and then $21.15.
Until then, silver remains in “prove it” mode despite this sexy looking rally. As you can see, these rallies have happened before and yet we're still in a condition of lower highs within that triangle.
That’s what we need to see to demonstrate that silver’s begun a genuine reversal into a bull market.
I’ll get to gold in just a moment. But first, I've talked a lot about the gold/silver ratio in the past, including the recent tendency of gold to trade at extraordinary levels relative to silver.
The gold/silver ratio comes from dividing the price of gold by the price of silver, by the way.
You can see that in recent times this ratio broke out to new all-time highs. Historically the high was just under 100 but now it’s reached 113 and 115, which is unprecedented.
Perhaps we shouldn't read much into it, but if there’s a regression to the mean, that suggests the ratio could drop to somewhere between the 50-90 level. That’s the long-term zone it’s traded in for the last few decades.
For this to happen, silver could rise while gold goes sideways. Alternatively, gold could plummet while silver goes sideways. But either way, this would deliver an acceleration of silver prices relative to gold.
So I'm certainly going to keep an eye on the silver chart because any penetration above recent highs, especially the $20 area, would indicate a potential drop of the gold/silver ratio back into its long-term trading zone.
It follows that we should be looking at XAUUSD (spot gold) too, so here it is:
Gold is continuing to hang around multi-year highs as it briefly surged north of $1,750 before settling back with a mini key reversal right at the apex of the reverse triangle. This reverse triangle is just a structure for me to observe prices – it may or may not mean anything, but you can see that gold has been bumping along the resistance level of this triangle for some time.
Gold did undergo a huge sell-off before, but it doesn't look like we're going to get another. However, when we see a key reversal where the price makes a new high and then closes near the low, lower prices often follow.
To me, the recent key reversal suggests we’ll see more consolidation and choppiness in gold.
That’s because I’m still on the sidelines with gold. I prefer to wait and see how it clears its major $1,750 level from here, or what it does if it dips. I want to trade with the best possible risk/reward outcome and right now gold isn’t offering a good enough bet for me to take.
Now here’s the NASDAQ stock index demonstrating the clearest possible evidence of why you can’t trade on the news.
So despite record unemployment, despite a 30% anticipated GDP contraction to the second quarter, the stock market is at or near record highs.
Price is the news. You can't fight the tape, you can't fight the market and in this case, the trend is your friend.
The NASDAQ has kept powering upward within an ascending broadening formation. And this is why patterns are informative.
It’s the same pattern in GBPAUD, and in that case the pattern acted as a reversal pattern. When GBPAUD broke below the ascending broadening formation, it sent prices lower.
But for the NASDAQ we may have the opposite phenomenon. The path of least resistance remains up. I would certainly not get in front of this freight train and try and short the NASDAQ at the moment.
Now for something new I haven’t shared before:
One of the more interesting trading opportunities in the stock market looks to be an ETF with the sticker symbol IBB, which is the biotechnology index. This tracks a number of biotech and pharmaceutical companies and the sector has been in a secular bull market for a long time now. Having said that, this index stalled in a trading range between 80 and 130 until last week.
That’s because last week IBB broke out to all-time highs.
I believe this breakout will translate to higher prices over time. I would handle this scenario by buying and holding this ETF with a view to the long term. Look at any retracement as an opportunity to take a long position within the long-term bull market in biotechnology.
As for price targets, the trading range is $50 and I would expect the market to run 75% of the height of that range. That suggests there’s $35 of upside if you buy on a pullback.
Those are excellent gains if you can get them, so seriously consider the IBB ETF as something to lock away in a part of your portfolio.
In the meantime, I’m bearish on GBP pairs (especially GBPJPY, GBPNZD, and GBPAUD), bullish on JPY (meaning that I’m bearish on GBPJPY and USDJPY) and also cautiously optimistic on silver and a potential narrowing of the gold/silver ratio.
So with that said, I wish you a healthy and prosperous trading week.
Mark "GBPPounded" Shawzin