There has been a lot of talk lately about the pressure the strengthening U.S. dollar is putting on commodity prices. To the extent that a higher U.S. dollar diminishes foreign buyers’ purchasing power, making U.S. goods more expensive, this is true. However, the rising dollar is not the only factor contributing to lower commodity prices.
Commodity markets fluctuate primarily in response to money flowing in and out of them. Initially, the fuel driving the markets higher was buying by speculators and hedgers entering the market in anticipation of higher prices. Then, suddenly, investor confidence was shaken first by the subprime mortgage fiasco and then by the uncertainty of whether the U.S. Commodity Futures Trading Commission (CFTC) would make regulatory changes, and how those changes might impact investors.
As available credit tightened, speculators had no choice but to reduce the size of the positions they were holding. Some sold to take profit, others to get out of their losing positions. This is referred to as “long liquidation” when traders unwind their long positions.
In this environment, it doesn’t matter how bullish the news is; prices won’t turn around until the liquidation is over. The exodus of participants from the market has been the No. 1 reason for the collapse in commodity prices.
The accompanying chart at right illustrates how the U.S. dollar has broken out of a downtrend channel. Channels are useful in determining trends and for identifying a change in direction. Both uptrend and downtrend channels are illustrated in the chart.
In a downtrend, the channel’s upper boundary is the downtrend line and it is drawn first. The lower boundary is the return line. It is drawn parallel across the lows of each progressively lower decline. This line is where prices are likely to bounce off of in a declining market.
In an uptrend, the channel’s lower boundary is the uptrend line and it is drawn first. The upper boundary is the return line. It is drawn parallel across the highs of each progressively higher advance. The return line points out the areas where reactions to the trend are likely to begin.
Trendline and channel construction develop because of unique behaviour. As a new uptrend begins to emerge, “buy” orders materialize just under the market. Some of this buying is satisfied on price declines. However, when the market stops going down, other buyers jump in for fear of missing the move and this causes prices to move back up. Most of these buyers will gradually increase their bids as the market advances.
Some profit-taking emerges as prices rally to new highs. This results in an increase of potential buyers getting back in when prices move back down. Their buying, as well as that of shorts eager to take profits during periods of price corrections, prevents remaining “buy” orders that are too far under the market being satisfied.
At the time of this writing (Sept. 11), the U.S. dollar is technically overbought due to the recent rally, and prices are challenging an area of resistance at 80.39. This suggests the U.S. dollar is vulnerable to taking a breather.
David Drozd is president and senior market analyst for Winnipeg-based Ag-Chieve Corporation. The opinions expressed are those of the writer and are solely intended to assist readers with a better understanding of technical analysis in the markets influencing agriculture. The information contained herein is deemed to be from sources that are reliable, but its accuracy cannot be guaranteed. Visit Ag-Chieve online for more educational tools and ideas about grain marketing, or call toll-free 1-888-274-3138.