EQUITIES AND FOREX

Traders looking to track the commodity and currency relationships should follow the
Commodity Research Bureau (CRB) Index. The CRB Index consists of a basket of commodities
and provides a useful measure of potential inflationary pressure. When commodity
prices rise, this price increase can spread into the economy by increasing the
costs of production and goods. This inflationary tendency is closely watched by central
banks. We can see in Figure 5.4 that at the end of 2006, the CRB Index showed a decreasing
price trend due to a collapse in the energy price sector.

The relationship between currencies and equities is an area of interest that is becoming
increasingly evident and important for traders to become knowledgeable about. For example,
when the yen is weak, Sony’s and Canon’s share values become more attractive
because they are exporters and, in effect, dollar earners. In all equity markets around the
world, exporting sectors benefit from a weaker home currency or the expectation of one.
DaimlerChrysler, Renault, and Peugot suffer share declines when the euro surges beyond
expectations. As we noted in our section on China (Chapter 4), when there is speculation
that the renminbi will increase, many Chinese equities increase in stock value due
to expectations that their assets will increase in value.
U.S. housing sector equities have a direct link to forex. For example, in December
2006, Black and Decker warned its shareholders that it faced “significant challenges” due
to a slump in the housing market. The equity market sell-off on February 27, when the Dow Jones Industrial Index suffered its worst day in four years, was a direct example
of the link between equities and forex. The sell-off was precipitated by a sudden fall in
the dollar against the yen. This decline caused a liquidity crisis as hedge funds needed to
sell equities to release funds to buy back their positions in the yen. (See Chapter 1 for a
discussion of this event.) As globalization increases, strong currency moves will impact
equity markets as it did on February 27. In a real sense, tracking equities where their
dollar earnings are important can benefit a trader in providing leading indicators of forex
price moves.
The relationship between the dollar and the equity markets is further underscored
by the Dow Jones Industrial Index reaching historic highs. This occurred as the USDX
entered into an extended downtrend (see Figure 5.5). Why has the relationship been inverse
between the equity market and the value of the dollar? A deeper look reveals the
answer. As the dollar value declines versus other currencies, the companies that export
to the rest of the world benefit from increased sales, as exports become more attractive
to foreign buyers. Additionally, multinational corporations having assets abroad experience
an increase in the dollar value of those assets.




By ABE COFNAS