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Louise Yamada Technical

Technical Research Advisors, LLC


Perspectives
L O U I S E Y A M A D A R O N A L D F. D A I N O
A l a n R. S h a w - C o n s u l t a n t E m e r i t u s May 3, 2006
Volume II, No. 18

MARKET HIGHLIGHTS

™ U.S. Stock Market: Status Quo.

™ Special Feature: Long Shadows on the U.S. Dollar – Poised to


Test / Break A 28-Year Support Into “Uncharted Waters?”

™ Currencies: U.S. Dollar -- Further Breakdown. A target to 80, a


critical structural support, can be calculated based on the breakdown through
our first target at 86.

™ Sub-Industries: Month-End Sector Commentary; Leaders Extend


Outperformance Profiles—Speculative Froth?

™ Stocks: Picture of Another Capitulation??

™ Metals: Spot Gold Surpasses the September 1980 Closing High at


666.75. Gold has cleared a 25 ½ year monthly high as a more structural
(long-term) consolidation phase with a further upside measured target of
1077.00.

™ Energy: Crude Oil Could Be Initiating Another Leg Up; Natural


Gas Initiating Another Leg Down!

™ U.S. Interest Rates: Some Support and Resistance Levels.

Louise Yamada, CMT Ronald F. Daino, CMT Jonathan T. Lin, CMT, CFA
louise.yamada@lyadvisors.com ron.daino@lyadvisors.com jonathan.lin@lyadvisors.com
Lori Altenburger Noreen Lennon
lori.altenburger@lyadvisors.com noreen.lennon@lyadvisors.com
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SPECIAL FEATURE: Long Shadows on the U.S. Dollar – Poised to Test / Break A 28-
Year Support Into “Uncharted Waters?”
The weakness in the U.S. Dollar index (DXY-85.75) over the past several weeks has caused us to
review our longer-term view of the dollar from a technical perspective (see Figure 2).
Figure 2. Dow Jones Industrial Average & U.S. Dollar Index

Data Source: Bloomberg

The U.S. dollar has essentially fluctuated in a 19-year trading range between a level of 80 and 100-105,
with a brief breakout into 2002 (see Figure 2). From 2002, the dollar experienced a steady decline into
2005 and, in the process, violated an eight-year uptrend and retreated to test the trading range support
at 80. A hiatus to the dollar decline occurred from 2005 to 2006. But now, the dollar once again has
lost its upward momentum, as my colleague, Ron Daino, has noted herein over recent weeks, with a
further break this week (see Currencies below).
The dollar’s critical support level at 80 extends as far back as even 1978, or 28 years (based on the
U.S. Trade-Weighted Dollar in Figure 3). It is this support level that concerns us now because,
technically, the longer a given level (support, resistance or trendline) has been in place, the more
technically significant that level becomes. Any violation thereof is considered a more serious technical
event fraught with potential for greater risk (or potential for greater reward); in this case, greater
depreciation risk. We are particularly concerned with this 80 level in light of the other major structural
20-plus year trend reversals that have taken place over the past six years (see Technical Perspectives
dated April 11, 2006).

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Figure 3. Trade-Weighted Dollar / London Gold Spot Prices

Data Source: Bloomberg

These observations are based on the Federal Reserve Trade-Weighted Dollar (see Figure 3). The
major currency index is a weighted average of the foreign exchange values of the U.S. dollar against a
subset of currencies of its major trading partners. The heaviest weight in the index is from the Euro
area, followed by Canada, Japan, the U.K., Switzerland, Australia and Sweden.

There is also the Fed’s trade-weighted dollar (the broad index), inclusive of all world currencies,
including several currencies (with China) pegged to the U.S. dollar. As can be seen in Figure 4, the
Broad Dollar Index has already violated a 23-year structural uptrend and has broken down
through a seven-year top (support). Today’s action puts in place a new reaction low. These
structural breaks act as a prelude to the technically anticipated support break in the other dollar
measures.

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Figure 4. U.S. Trade Weighted Broad Dollar Index

Data Source: Bloomberg

U.S. Dollar History


Our observations of the U.S. dollar behavior go back to the mid-1990s, when the general fundamental
concern at the time was that the then-strengthening dollar could cause a tumble in the stock market
(particularly because of the perceived negative effect on U.S. multinational companies). In our studies,
we have found, interestingly to the contrary, that the dollar’s trend progression over the longer term
(defined as the above multi-year trading range in force for the dollar) seemed to allay that concern.
Looking at the U.S. Dollar Index (see Figure 2) in the mid-1990s, the dollar had essentially been in a
trading range between 80-85 and 100-105 since 1987. Within that range the bullish technical
observation suggested that, throughout that trading range, a strengthening dollar was, in fact,
accompanied by a stable-to-rising equity market trend (encouraging foreign money to test the U.S.
equity markets?).
On the other hand, one can see that the declining equity market periods (comprising the bear markets
of 1987, 1990, 1994, 1998 and 2002) corresponded to a weakening underlying dollar structure.
Nevertheless, a weakening dollar does not mandate a falling equity market (note the 1992 and 2003-04
exceptions that make the rule). Yet, what is evident is that when the equity market has been weak
throughout the trading range, that market decline has always occurred against a weakening
dollar (see 2002).
Black Market Bubble
In the late 1990s we set forth the caveat that, were the dollar to break out of its trading range, the equity
market expectation would enter “uncharted waters.” Such a breakout occurred in May 2000, which we
dubbed the “black market bubble.” The “black market bubble” was an aberration resulting from the
initiation of the Euro: In early 2000, there was an announcement that the Euro would represent the only
legal tender as of January 2002. It has been our belief that all the underground francs, deutschemarks,
and lira went into the dollar from that announcement, and exactly in January of 2002, was transferred
into Euros!!.
Regardless of the reason, the dollar breakout through the (by then 14-year) trading range in 2000 gave
us technical concern as to the contingent implications of the excess dollar strength, particularly as we
were already identifying underlying technical weakness in the equity market and the Fed was lifting
short-term interest rates from 5%-6%. The rest is now history.

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Major U.S. Dollar Sell Signal
Accompanying the bursting equity market bubble, the dollar retreated back into its familiar trading
range. In the early course of the dollar’s decline, our technical indicators registered a long-term Sell
signal in May 2002, technically suggesting an extensive downtrend ahead which could carry
targets to 106, 100, 95 and 85. All were realized, as well as an additional slip toward 80, concluding
that the dollar could remain on the defensive through the remainder of this decade. (Technically, the
greater the decline, the longer the need for repair.)
An equity bear market decline into the 2002 low (and the 2003 test of the low) accompanied the dollar
decline. But the dollar decline continued even as equities recovered in 2003-04, creating only the
second exception to the “weak dollar, weak market” observation relative to the history of the trading
range.

Recent Dollar Behavior – Double-Edged?


The U.S. dollar spent the past two years attempting to stabilize above the multi-year support level at 80,
even at one point presenting the possibility of a technical “head-and-shoulders” reversal pattern
carrying positive underlying technical momentum support (see Figure 2). But that support began
fading over the past month and a half, and the symmetry for completing that technical pattern to the
upside dissipated in March 2006. Even as interest rates continued to lift (which in theory should
provide support for the dollar), the dollar could not rally.
The equity market may be at a somewhat delicate juncture with the tenuous current dollar position,
even in face of rising interest rates. A further weakening dollar, from this point, in conjunction with
rising rates, could compound the underlying risk for an already increasingly selective equity market.
And a further dollar decline could create a withdrawal of foreign funds from our equity market.
On the other hand, were rate increases discontinued, the dollar would theoretically lose that interest
rate support and weaken further. Our technical targets (see Currencies below) now suggest a break of
the 28-year support. From a technical perspective, a break below 80 would once again put the U.S.
dollar in “uncharted waters,” this time to the downside, raising our technical concern as to the
implications of excess dollar weakness.
We might find that an excessively weak dollar benefits the earnings of U.S. multi-national companies,
which in turn, could strengthen today’s equity market leaders (Industrials, Materials, Metals, Gold,
Energy and Rails) as they participate in the global build out and could be boosted by a weaker dollar.
(But this would require an orderly dollar decline.)

Laissez Faire Devaluation


The “laissez faire” devaluation of the dollar in 2002 was second only to The 1985 Plaza Accord, the
negotiated devaluation of the dollar (47%) into 1987. Were the current “laissez faire” dollar
devaluation to suffer an equivalent decline to that of The Plaza Accord, from the 2002 peak, the
dollar value would translate to a level of 60!!
If the U.S. dollar were to break below the 28-year support range, as our technical targets now
suggest is a very real possibility, doing so would carry the dollar to the lowest level in the past
35 years, since the U.S. abandoned the gold standard in 1971, a message in and of itself as to the
structural bull market in place for gold (see Figure 3). Since the gold window closed, the dollar and
gold, with few short-lived exceptions (see Technical Perspectives dated November 23, 2005) move
inversely to one another.

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Editorial Commentary -- The Turning of the Screw -- Other Factors at Play Today.
The lesson: Large and rising government deficits eventually result in a weak currency. Growth driven
by high levels of business investment leads to currency strength. But growth driven by strong
consumption and government spending (as is now the case in the U.S.) leads to currency weakness.
The technically weakening dollar profile should come as no surprise as we observe the global
environment around us:
• The trade deficit at year-end 2005 at $800 billion and climbing;
• The budget deficit just for the war in Iraq at billions of dollars a month;
• China holds nearly $1 trillion of our debt, mostly in U.S. bonds;
• Japan holds nearly the same amount;
• $1 trillion was added to the broad money supply in 2005 alone; and
• The Fed is raising rates with one hand and printing dollars with the other (no longer publishing
M3, to keep it from the public eye). Is it any wonder rising rates could not support the dollar?
Or that China is being encouraged to revalue?
Probably one of the greatest concerns is that the global anti-American sentiment that has been seeded
over recent years and which is growing so well, is also sprouting local national protectionism in many
countries:

• Venezuela mandated that royalties for oil must be paid in oil, not dollars;
• The growing bias on the part of other countries not to accept dollars for oil, requiring Euros
instead;
• Iran may be creating an oil bourse in both Euros and dollars;
• The Saudi’s recent decision to charge the U.S. more for oil than what they charge the United
Kingdom or Asia;
• Central banks are shedding excess dollars, euphemistically under the guise that other
currencies are “underrepresented in their global currency reserves” (Sweden, Quatar, UAE and
other Middle Eastern countries, as examples, with Russia and China to follow suit, “diversifying”
national reserves, by replacing dollars with Euros;
• Developing nations that have held dollar reserves as insurance may now find better investments
elsewhere as those reserves depreciate;
• Central banks are no longer selling, some even buying, gold (Quatar and China as examples) to
eliminate excess dollar reserves;
• The result had been seen in a drying up of demand for our government debt;
• The Saudi news services advising caution about investing in the U.S.;
• Papua wants to nationalize their ores;
• Bolivia has just nationalized its natural gas; and
• Zimbabwe seeks to take control of foreign run gold mines.
The generally accepted view of the U.S. as the engine of the world (that if our economy slows,
so goes the world) may be a major error of analysis today:
• The U.S. is now responsible for only half of the global GNP, no longer a majority.
• Exports to China from Korea and Japan are larger than to the U.S. (growing their economies).
• Europe is exporting more to China than we are.
• Alliances and trade agreements between Russia and China, Russia and Iran, Saudi Arabia and
China, Canada and China as examples are cropping up, exclusive of the U.S. and its interests.

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• Are the U.S. economy and bond yields as important abroad today? -- less likely to influence the
growth in developing nations? One might simply note who has the productive growth today, and
who carries the burden of unproductive debt.
We reiterate our belief that a structural global bull market (ex. U.S.) may be in place, similar to the
1942-66 structural bull market that the U.S. experienced: “Less Americentric”!!!
The U.S. may have the greatest to lose over time.
Let us not forget history. In the 19th century, the economic strength rested with England and the
British pound was the economically strong currency. In the twentieth century, the U.S. became the
economic leader and the dollar the currency of trade. It is becoming clear that the dollar may not
remain the reserve currency of the world.
It is not inconceivable – maybe even inevitable - that in the twenty-first century, China will become
the economic leader, and we may find the Yuan as the currency of trade!!!
Louise Yamada

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LOUISE YAMADA TECHNICAL RESEARCH ADVISORS, LLC


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New York, NY 10036
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research is based on analysis of the current price performance of a security as compared to its historical price performance,
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performance is not necessarily a guide to future performance, however, and technical analysis alone should not be relied upon
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Copyright 2006 Louise Yamada Technical Research Advisors, LLC. All rights reserved.

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LY ADVISORS: Technical Perspectives May 3, 2006

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