G10 Currencies Signal the Coming Bear Market

The PowerShares DB G10 Currency Harvest Fund (symbol "DBV") may not be familiar to a lot of you. However, this fund is based on the Deutsche Bank G10 Currency Future Harvest Index - Excess Return™ (Index) and managed by DB Commodity Services LLC has been in existence since September 2006 and is an easy way to get a view of world currencies vs. the U.S. dollar.

The Index is comprised of currency futures contracts on certain G10 currencies and is designed to exploit the trend that currencies associated with relatively high interest rates, on average, tend to rise in value relative to currencies associated with relatively low interest rates. The G10 currency universe from which the index selects currently includes U.S. dollars, euros, Japanese yen, Canadian dollars, Swiss francs, British pounds, Australian dollars, New Zealand dollars, Norwegian krone and Swedish krona.

In the chart below, we see that a spread between DBV divided by the S&P 500 index ($SPX) has been moving up again since April. This spread should increase when either the basket of foreign currencies increases relative to the change in the value of the S&P 500 or the S&P 500 declines relative to the basket of currencies.

If we overlay a 50 week exponential moving average, we can see that when the spread breaks below the moving average, this is bullish for equity markets. When it moves above the moving average, this is bearish for equity markets.

click to enlarge

From the chart above, you can see that we are at a critical juncture. Either we hold and markets strengthen here in the U.S. or the U.S. dollar and/or markets fall allowing the spread price to move above the 50 week moving average which will confirm a change in trend.

Note the S&P 500 is highlighted in light green behind the black and red spread chart of DBV and the $SPX. You can see the inverse relationship that exists between the spread and the S&P 500.

Disclosure: Author holds a position in SDS

Comments

[Matt Kruyswyk]

DBV seems to be a carry trade substitute; i.e. "risk on". I was under the impression that the S&P was also in the "risk on" bucket

Jul 13 09:03 AM

[Daily Trading]

DBV is denominated in USDs so USDs cannot be in its universe. It selects currencies from the G10 ex the USD. You may also want to check out CEW as well

Jul 13 06:04 PM

[Private Citizen]

>>DBV is denominated in USDs so USDs cannot be in its universe. It selects currencies from the G10 ex the USD. You may also want to check out CEW as well

Portfolio Construction (care of M*)

This fund is based on the Deutsche Bank G10 Currency Future Harvest Excess Return Index, which invests in long and short three-month currency futures in order to capture the spreads on the risk-free yields between the different currencies. Each quarter, it rebalances by first identifying the three-month Libor rate in each of the G10 currencies: U.S. dollars, Canadian dollars, Japanese yen, Australian dollars, New Zealand dollars, British pounds, euros, Swiss francs, Norwegian krone, and Swedish krona. The fund then buys long positions equal to one third of the fund's assets in three-month futures for each of the three highest-yielding currencies and sells short positions equal to one third of the fund's assets in three-month futures for each of the three lowest-yielding currencies. If the U.S. dollar is one of the six currencies that yields the least or the most, that long or short position is ignored for the quarter and the fund has only 1.66x leverage from the other five futures positions. While using the fund's cash as collateral for the futures contracts, management also invests the assets in three-month T-bills to provide additional yield above the benchmark index.

Jul 13 08:50 PM

[whidbey]

Jeff
Very good and concise insight. You are, of course, correct too. The obvious move in my mind is down, and soon, for the SPX. The currencies are merely telling us that when things go to hell they do in concert. I fear we have a near collapse coming this month or August, and I think it is part of a cyclical depression where most investors will not survive.

Thanks you are a cut above the average and I hope you post more.

Jul 13 07:36 PM

[japan20000]

what I see in this chart is negative correlation with no predictive power

Jul 14 02:19 AM

[granger]

Interesting take, you have given me food for thought. I will remember this relationship and watch.

For what it is worth, on a DBV Point&Figure chart, it gave a sell signal at 22 on May 20th

On a Relative Strength basis DBV vs SPX, the P&F chart went to O's on April 09,2009, then on March 17,2010 the relationship gave a RS sell signal

for what that is worth, I need to think about more

Jul 14 06:46 AM

[Jeff Diercks]

Thanks guys for weighing in. This graph is not the "holy grail." It is just another data input to think about. As Matt pointed out above it is a bit of a "risk on" / "risk off" and can be affected by the dollar movements to extreme relative to U.S. equities.

In my mind, today and possibly tomorrow's price action in stocks should really tell us whether we maintain a downward bias for equities or miraculously recover again.

Jul 14 09:53 AM

[granger]

yeah, we need to get through expiration to see what people are really thinking

Jul 14 05:07 PM