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With the trade weighted U.S.
dollar seemingly in a death spiral, the idea of sustained dollar strength
against one of the major currencies may appear laughable. Yet that is a
viewpoint that we wish to consider at this time. Specifically, we want to
examine the prospect for a strengthening dollar versus the Japanese yen,
i.e., potential for serious yen futures weakness as this year progresses.
The cash yen chart
(inverse to a futures chart) shown below provides a post World War II
perspective of the U.S. dollar - Japanese yen relationship. From a high in
1950 when a dollar would buy 600 yen, values moved to an eventual low in 1995
(circled point 5 on the chart) when a dollar would buy about 85 yen. [As an
aside for those who are interested in historical trivia, we would note that
during 1946 - 1972 the yen traded in a black market]. Clearly, the dollar is
in a secular bear market against the yen. While we do not want to make the
mistake of opposing a major trend, we see an accumulation of evidence that
suggests the potential for a pending period of USD/JPY strength similar to
that which followed the 1995 low. We want to discuss salient points that
pertain to the above cash chart and then move on to examine various futures
chart related factors.
 
In the time that has
followed the 1995 low we have observed (in non-related publications) that the
1950 - 1995 downtrend in the USD/JPY has classic technical symmetries. First,
waves 1 and 5 are near equality in size. Wave 1 covered 245 points while wave
2 covered 200 points. Second, wave 2 and wave 4 are equal in size, that being
100 points. Another typical technical factor is that the approximate symmetry
of waves 1 and 5 is a typical relationship when the intervening wave 3 is
large relative to wave 1. Also, as we interpret it, the structure of wave 5
has five subdivisions (annotated i - v) that imply a completed sequence. Taken
together, all of these points favor the view that the 1995 low was a terminal
low for the fifth wave and, therefore, for the entire 1950 - 1995 wave
sequence. Thus, over the past few years, we have been anticipating a
generally higher USD/JPY market as the long-term downtrend undergoes a normal
correction. Although the 1995 -1998 recovery to point A3 was respectable, it
was nowhere near as large as the wave 2 and wave 4 corrections that occurred
in the prevailing downtrend. That leads us to expect that the USD/JPY has
further up leg potential unless we are dead wrong on the market having
reached a sequence low in 1995.
We have long
considered that Japanese demographics will ultimately weigh on the yen
relative to the dollar. While the preponderance of technical evidence that we
consider here appears to favor the prospect for renewed intermediate- to
long-term yen weakness, we would be remiss if we did not first discuss the
technical case for a resumption of the long-term cash USD/JPY bear market
(Japanese yen futures bull market). Here we switch our focus to futures
charts.
As we see it, the
primary argument for a long-term uptrend resumption in yen futures hinges on
wave analysis. The weekly Japanese yen chart below illustrates this. Since
the 1995 high at 1.2625¢, the market developed a deep 3-swing decline, a
zig-zag annotated a5 - b3 - c5, to circled point A in 1998. A 3-swing rally, an inverted flat annotated a3 - b3 - c5, followed to circled point B in 1999. Finally,
in this interpretation, values traced out a 5-swing decline to circled point
C in 2002. That is an approximate Fibonacci-related 78.6% retracement of
circled wave A and could comprise a deep "test" of the circled A
low. The whole A - B - C sequence, composed of 3, 3, and 5 subswings, would
be termed a large flat correction that had a C-wave "failure"
(i.e., the C-wave bottomed atypically above the low of the A-wave). That
interpretation would lead us to conclude that the 5-swing advance that we
have annotated from circled point C is the start of a new bull phase.
Our approach to wave
theory is that pattern "failures" can be valid but they have their
place. We think that markets tend to behave "normally", however
tenuous that term may be, and that "failures" are exceptions. Typically,
we associate "failures" with patterns that are within larger
structures rather than with whole structures. For that reason, while we do
not rule out the validity of the above wave interpretation, we are dubious of
it. We favor alternatives that imply opposite long-term price potential.
In the weekly
Japanese yen chart below, overall swings since 1995 imply a bearish outcome. Whether
that is imminent or not is debatable but evidence that we will examine later
implies imminent potential. This wave interpretation also includes a zig-zag
decline from the 1995 high to the 1998 low at boxed point A and an inverted
flat rally to the 1999 high (circled point A3). From that point on, the
interpretation varies from the bullish interpretation on page 2. Here, the
1999 - 2002 decline to circled point B3 is seen as being a flat that has 3
swings, [annotated a - b - c, with the c-swing further subdividing into 5
subswings (i - v)]. Since legs A3 and B3 are back-to-back 3-swing moves, we
can infer that a larger pattern is unfolding and that its next leg, labeled
C5, could consist either of 3-swings or 5-swings. A 3-swing scenario would
imply that pattern development since boxed point A is a triangle. Our
subjective judgment considers that to be a low probability event. At this
time we are working with the 5-swing scenario. That could accommodate an
imminent conclusion to leg C5 that is below circled point A3 (.9990¢) or
one that is further out in time and that is higher in price than point A3.
Our working premise
at this time is that price swings since the 1998 low are forming a B-wave
that could have the appearance of the inset schematic diagram. This stance
should be proved or negated in short order since price action in the past
week featured a collapse from a trend high at $.9518¢ which was just
above the Fibonacci-related 78.6% retracement of leg B3 (shown at
.9439¢). If the ongoing C5 leg is to fail below point A3, then this is
the area for it to do so.
Let's look at some
classic pattern comparisons that bolster the case that the yen may be nearing
an interim high. The first chart above compares ongoing yen weekly chart
activity from the 2002 low with a daily silver chart from 1980. Annotations
are for clarity and have no Elliott wave significance. The silver chart on
the left featured a dynamic and classic 3-swing bear market rally. Following
an initial upthrust, prices consolidated in a triangular pattern and then
completed the pattern with an upside gap. This chart also featured a swing
relationship where the length of leg BC was a Fibonacci-related 1.38 times
the distance of leg A. The yen chart on the right shows similar pattern
development that includes the triangle pattern and a gap following its exit
thrust. This chart lacks the explosive dynamics in both its A' and B'C' legs
that silver exhibited in its respective legs. There is no swing relationship
on the yen chart although leg B'C' would have equality with leg A (i.e.,
swing rule target) at .9566¢. The high to date is .9518¢.
Our second pattern
comparison, below, is that of ongoing weekly yen activity and a weekly
Treasury bond pattern in the 1980s. Again, annotations are for clarity and
have no Elliott wave significance. This is strictly a pattern comparison exercise
where T bonds had an initial 3-swing rally (A - B - C) from point 0, a retracement (D - E - F) that featured only a marginal new low at F, and then another 3-swing
rally that was complicated by erratic consolidation until point Y when price
acceleration occurred. The move concluded with a diagonal triangle (rising
wedge) that featured a failed upside exit thrust and top reversal range at
point Z. In similar fashion, the Japanese yen has traced out what appears to
be a diagonal triangle that is at the top of the larger pattern.
These two examples
compare ongoing Japanese yen pattern development with historic patterns that
occurred either as an outright bear market rally, as in the case of silver,
or an unsustained intra-pattern rally, as in the case of Treasury bonds. The
pattern similarities imply downside potential in the Japanese yen once its
current 2002 - 2004 pattern reaches its conclusion.
A final chart, the
daily continuation chart below, considers recent wave development. If we are
correct in our page 3 interpretation of the market being in the fifth leg of
a 5-swing advance, then we should expect to see 5 subswings from the August
inception point of the latest move. As we see it, prices have established the
requisite wave structure and last week's aggressive collapse bolsters the
view that the fifth swing has terminated.
In summary, a 1995
cash Japanese yen low (futures high) has potential to be a trend extreme that
is not exceeded for many years. Following the first recovery from that
extreme, price action during 1998 - 2003 has traced out respectable, but
unsustained, intermediate-term trading swings. However, in the very long-term
context, the overall condition has been one of a broad equilibrium. At this
time, we think that the market has reached a level that could mark the
conclusion of that equilibrium. Because of the various factors outlined
above, we are watching market behavior for signs of an imbalance that could
mark the start of a sustained breakdown in futures prices. Trading activity
in the week ended February 20, 2004 featured a stochastic downturn that
confirmed a bearish price/momentum divergence on the daily yen futures chart,
a weekly stochastic downturn that confirmed a bearish price/momentum
divergence on that chart, weekly downside range expansion that violated a 3 month
support line, and enough range expansion on the monthly chart to establish an
"outside" range that has top reversal potential depending on where
the February 27 close is situated. Also dependent on that level is a
potential monthly stochastic downturn. All of these factors suggest to us
that the Japanese yen will face weakness, possibly a collapse, relative to
the U.S. dollar as we move further out into 2004.
Our current trading
strategy is to be a seller of the March or June Japanese yen futures. We would
place stop-loss protection above .9400¢, basis spot month futures, and
anticipate near-term downside potential into the September 2003 gap at
.8893¢ - .8769¢. If the market fulfills that area and subsequently
overruns it on the downside, then we can give serious consideration to the
idea that the 1998 - 2004 consolidation is being resolved and that a major
down phase toward .6000¢ is starting.
Eidetic Research
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