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About two months ago I wrote about the extreme sentiment in both the Euro and the US dollar, suggesting that the two important reserve currencies were at an inflection point: Fading Iran’s Central Bank.
Sentiment, as measured by the Daily Sentiment Index was extremely poor for the Euro with only 2% of retail investors saying that they would go long the currency. As well, another sign was the panic from the Iranian Central Bank.
Here is a recent chart of the Euro index showing how it recovered from the lows in early June 2010:
The first arrow points to mid-May when the DSI hit 2%. This was incredibly lower than the previous low of 6% which it hit bank in late 2005 - an important multi-year low. The second green arrow points to early June, around the time I highlighted the Iranian Central bank’s reaction to the weakening Euro.
Sentiment isn’t a perfect market timing tool but here, once again, we see the power it has in pointing out important inflection points. The Euro did fall lower after the DSI’s abysmal showing but it was short lived and in comparison to the ensuing rally, the incremental decline was quite small.
Turning to the US dollar, it looks like the same chart, just turned upside down:
In early June 2010, the DSI for the US dollar hit 98% - an unquestionable extreme, even higher than the sentiment levels reached in early 2009: “Anything But Euros” Pushes Dollar Sentiment To Extreme.
And once again, contrarian analysis of sentiment proved its mettle with the US dollar currently down significantly from the early June 2010 highs.
If it helps, think of sentiment as a compass pointing you in the general direction. You still have to pick your way through the underbrush. Many people who fail to grasp its power demand too much of it (to extend the analogy, they think it is a GPS system).
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