Intermarket relationships

Few variables in finance are blamed or credited improperly for influencing other markets as much as is the USD. How can we be so confident in others’ ability to get it wrong? One way is to display a set of one-year rolling correlations along with prices indexed to Jan. 4, 1999 = 100 percent of the DXY against other key markets. If a market such as the DXY causes another’s movements, the correlation between the two should both be stable and should never switch signs. This is most certainly not the case with the DXY.

The unstable correlations seen to create trading opportunities. They also provide useful analytic information for those who focus on the non-DXY markets and who may wish to sidestep the poor analysis so widely available in the public media.

The correlation between the DXY and ten-year notes is an excellent case in point for these observations. It presently is highly negative; that is a stronger DXY is associated with higher bond prices. Such was not the case from mid-2001 though 2003 and again from the spring of 2004 through mid- 2005. A trader aware of these shifts should be able to profit from them.

We can make a similar statement with regards to commodity prices as represented by the Reuters/Jefferies CRB index. At present, a stronger DXY is associated with higher commodity prices; the precise opposite was true in the second half of 2005 and during several earlier periods. Those who blithely attribute higher commodity prices to a weaker dollar have some explaining to do.

We can extend the relationship noted for the CRB index to the single commodity of gold. Gold is commonly regarded as a way to protect against dollar weakness, and yet it has been strongly positively correlated with the DXY of late and for most of the 2002 - 2005 period. In fact, only during the apex of the gold rally in late 2005 early 2006 did the two markets exhibit the expected negative correlation.