Time To Get Bullish On Commodity Currencies?

Fundamentals

Traders and investors are brushing off their old “Economics 101″ text books to study-up on the term “Quantitative Easing” that has been the buzzword moving about from Central Bank to Central bank this year.

A general definition of quantitative easing is the creation of a quantity of new money through open market operations by a country’s central bank in order to increase the money supply. In more layman’s terms it is the printing of new money to purchase government securities which has the effect of injecting the newly printed currency into the private banking system.

This action is intended to help stimulate economic growth, with banks hopefully lending these newly created funds. However, the creation of money seemingly out of nowhere has the potential to lead to rising inflation down the line, as the effects of this monetary stimulus moves its way through the economy.

The Federal Reserve is the third of the major Central banks to embrace quantitative easing as a means to keep interest rates low and spur lending, along with the Bank of Japan (BOJ) and the Bank of England (BOE).

The most notable exception so far has been the European Central Bank (ECB), but many analysts believe it will be more a matter of “when”, not “if” the ECB will embrace this potentially inflationary policy to help stimulate economic growth.

So where should traders look for potential opportunities to take advantage of this move towards “Quantitative Easing”?

Given the potential for rising inflation and potentially higher commodity prices, traders may want to look towards the so called “commodity dollar currencies” such as the Canadian and Australian Dollars. Rising commodity prices is usually deemed supportive for those countries that are net-exporters of commodities such as base metals or oil. Though both the Canadian and Australian Dollars have risen vs. the U.S. Dollar the past few days, they are still well below the levels seen last year when commodities were all the rage.

Those traders who have followed the Canadian Dollar futures will know that the June futures contract has made several attempts to break below the 0.7650 area and as failed each time. Traders with a bullish slant towards the Canadian Dollar who believe the 0.7650 level will hold could write bullish put spreads on the Canadian Dollar.

An example of a trade is selling the June 7650 put and buying the June 7450 put for a net credit of 30 points or $300 per contract, with the June futures trading at the current level of 0.8078. This trade will be profitable if the June futures contract is trading above 0.7620 by expiration, with a maximum profit of $300 if the futures are above the 0.7650 level at expiration. The maximum risk for this trade is $1700 if the June futures fall below 0.7450 at expiration.

Technicals

Turning to the daily chart for the June Canadian Dollar futures, we notice the sharp breakout after the recent Fed announcement towards quantitative easing. Prices also broke above the 20-day moving average, which many short-term momentum traders look to for a buy signal. The run above psychological resistance at 0.8000 also sparked a round of short-covering buying as buy-stops were hit.

Momentum as measured by the 14-day RSI is reading a moderately positive 63.93. The next resistance point comes in at the trendline formed from the November 5th highs near the .8270 level. Support is seen at the contract lows made on March 9th at 0.7666.

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Comment by Luc Chase

2009-03-23 11:40:14

Premature… deflation is still the only reasonable outlook.

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