The End Of The Relief Rally In A Safe Haven Trio (Yen, Treasuries, Gold) Is In Sight

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by: WingCapital Investments
Summary

The U.S. dollar has pulled back after the explosive Trump rally ran out of steam, leading to sharp relief rallies in yen, gold and US Treasuries to start 2017.

Both the yen and Treasury Bond yield are following a similar historical pattern which is signaling an end to the recent rally in the next few weeks.

Gold remains highly correlated to yen since the beginning of 2015 and will most likely continue to follow the yen’s footsteps.

In the medium term, yen, gold and U.S. Treasuries likely remain on the backfoot as fundamentals point to stronger U.S. dollar and higher interest rates.

Towards the end of 2016, we had suggested a temporary pause to U.S. dollar's (NYSEARCA:UUP) explosive rally since election, based on how closely the U.S. dollar Index (DXY) has been following the technical chart patterns from 1999-2000. To recall,

Party Like It's 1999 for the U.S. Dollar

So far, the analog continues to play out nicely to kick start 2017, with the DXY selling off pretty much right from the get-go, down 2.5% since peaking on January 3rd. The euro (NYSEARCA:FXE) rallied 1.5% while the yen (NYSEARCA:FXY) outperformed with a 3% gain vs. the U.S. dollar year-to-date. That being said, we believe that the retracement in USD/JPY is nearing its end, as we observed that the strong move off the lows in September last year and the subsequent retracement closely resemble that from the same period in 2014-2015.

USD/JPY - Now vs. 2014-2015

(Source: WingCapital Investments)

As illustrated in December's piece, we believe that the up and down swings in the yen have been largely driven by large speculators based on how price has moved in tandem with the net exposure in large specs. Furthermore, it appears to be a recurring end-of-year theme since 2013, with the net short exposure spiking into year-end and leading to a substantial drop in the yen, before the short positions are squared up to start the year:

Yen Futures vs. COT Net Positioning of Large Specs

(Source: Finviz.com)

Hence, it will be worthwhile to continue following the Commitments of Traders report every week to monitor the extent of the short covering by large speculators. We are in the camp that yen will resume lower in the medium term after the recent short squeeze plays out.

Meanwhile, a similar picture in the Treasury 30-Year Bond yield (NYSEARCA:TLT), which also shows that the current chart pattern since beginning of 2016 bears striking resemblance to the one between mid-2014 and 2015. Should the analog continue to play out, bond yields should bottom around the end of this month and resume higher.

30-Year Treasury Bond Yield - Now vs mid 2014-2015

(Source: WingCapital Investments)

Gold (NYSEARCA:GLD) is the other safe haven play which had been decimated along with yen and Treasuries since peaking middle of last year. Indeed, gold has essentially been following the footsteps of the yen, with the inverse correlation between USD/JPY and gold about 82% since the beginning of 2015. Fundamentally, the correlation makes sense given their safe-haven statuses and zero-yielding nature, and hence we do not expect the correlation to significantly change going forward.

Gold vs Yen Inverse Correlation since 2015

(Source: WingCapital Investments)

Given the harmony of the technical patterns represented above for the yen, Treasury Bond yield and gold, the relief rallies in the safe haven trio off oversold conditions are likely to run out of steam soon. Fundamentally, higher growth and inflation prospects continue to suggest higher interest rates and U.S. dollar. We wrote this article prior to the inflation data release on January 18th, but decided to update to keep readers posted. Per 24/7 Wall Street,

The headline CPI report for December was up 2.1% from December of 2015. December's core CPI reading was up 2.2% year over year. There have been many months in which one of the indicators was challenging the 2.0% annual reading. In this report, the annual readings are both above the 2.0% target. What matters here is that this should offer Yellen and her Fed cohorts on the Federal Open Market Committee (FOMC) more than enough cover to justify its next interest rate hike.

We also had Janet Yellen's speech on the same day, during which she reiterated that there will be a few rate hikes coming up this year. She noted that inflation "starts inching back toward 2% last year as the job market continued to improve and as the effects of a big drop in oil prices faded."

YELLEN: The Fed is close to its goals and expects to hike rates 'a few' times this year

Similar to the yen, Treasuries and gold, we believe that the recent selloff in U.S. dollar was driven by technical factors even though long-term fundamental picture remains bullish. As such, the yen, Treasuries and gold will mostly be on the back foot after the relief rally runs out of steam. We have covered our USD/JPY short as a result, and recommend scaling in USD/JPY longs from 113 for a target of 120 with a stop under 110.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.