Independent market research for the future investor.

Background 

The Norwegian Kroner (NOK) has come under a fair amount of scrutiny in the past few years, as it has underperformed against several key European currencies, in addition to commodities, such as oil. The overriding factor for this has been diminishing oil production in the absence of new oil fields. Put in perspective, this dilemma bares greater significance since export revenue generated from crude oil and refined products accounted for 56.5% of Norway’s total exports in 2018, portraying the country’s heavy dependence on this industry.  

Unlike their Nordic neighbours, Norway have not developed into other sectors such as automobiles, furniture making or even Lego, making their reliance on oil evermore crucial. Overall, this illustrates that the repercussions of Covid-19 cannot be solely responsible for the enormous depreciation in Norwegian Kroner, but rather, its long-term fragility is definitely a culprit in amplifying the situation.  

As shown in the red box below, the currency pair was floating in quite a predictable range from September 2019 to the end of February 2020. However, courtesy of effects from Coronavirus, the NOK-EUR pairing depreciated to a historical low of 0.081 on March 19^th. Since then, the currency pairing has partially recovered to a present value of 0.094, however, this is still short of pre-virus levels. An alternative, and perhaps clearer manner of viewing this is that on New Year’s Day, it cost NOK 9.38 to buy a Euro whereas at the height of the Kroner’s slump, it cost NOK 12.16 – a devaluation of a somewhat staggering 29.6%.  

Fundamental Analysis 

Essentially, the instability and sudden nature of Covid-19 is the overarching cause for such a profound depreciation in the Norwegian Kroner. However, it’s indirect effects on other currencies and commodities have also had a detrimental impact on the currency.  

The main effect has been plummeting oil prices. This is due to a huge demand deficiency for crude oil, mainly from reduced transportation volumes via airplane. The IEA estimating drop in demand to be approximately a million barrels per day during the March-April period. Another cause for the drop in oil has been Saudi Arabia’s involvement in flooding the global market with oil and offering discounts to buyers, in an attempt to acquire greater market share. This has caused a major supply shock in the oil market and consequently, caused the price to plummet to its lowest level since 2003, where on March 18^th, a barrel went below USD 25. Because crude oil is a commodity which is only traded in USD internationally, and is such a fundamental segment of the Norwegian economy, any fluctuations in its price is mirrored in the Kroner’s value. This is why the steep drop in the currency’s worth, compared to the Euro, can be observed.  

However, from lowest value of NOK-EUR, there has been a progressive rise in the relative strength of the Norwegian Kroner. One reason for this is actually quite unexpected. An empirical study done in 2002, by Q. Farooq Akram, based on the co-variance and correlation between the Norwegian Kroner and oil prices demonstrated that when the price of a barrel of crude oil falls below USD 14, it has an inverse, non-linear relationship with the price’s movement.**  

Part of the econometric model derivation (Akram, 2002) 

This trend is definitely replicated in the case of NOK-EUR since oil prices continued to fall below USD 25 to USD -37.63 by April 20^th, which by then, the currency pairing was on the uptrend. 

Besides this explanation, Norges Bank’s active approach in aiming to stop the deprecation of the current has been gratefully recognised as in past encounters, they have shown reluctant to step into the market, favouring verbal intervention only. Nonetheless, they have implemented various strategies which include: 

• Slashing the policy rate from 0.75% to 0.25% to encourage spending in the economy, whilst heavily supporting banks by extending the F-loan scheme in order to free up liquidity for lending to individuals and businesses. In turn, this has already aided to boost confidence and economic prosperity, thus causing NOK to appreciate.  

• Utilising Norway’s extremely advantageous giant sovereign fund, which stands at over $950bn. The fund has gained in foreign currency positions during the pandemic and subsequently, its value has risen, enabling Norges Bank to comfortably tap into it and spend close to 6% of its worth. This has had a similar effect to quantitative easing, which is a relief since Norway’s small and illiquid bond market makes this difficult and ineffective.  

• Selling off foreign exchange at the rate of NOK 2000 million every day in order to purchase their own currency and stimulate excess demand. Therefore, this would drive the Kroners’ relative value upwards and prevent foreign investors shorting the currency in their portfolios – hence preventing the currency from fluctuating aggressively on the FX market. 

Overall, these initiatives have helped in the appreciation of NOK-EUR, since its mid-March plummet, as it has rebounded 12% against the Euro and has outperformed it on average in the past 3 weeks. Overall, NOK-EUR appears to have forward momentum, but with many variable factors such as a potential second Covid-19 peak in Europe marring the scenery, it might be naive to not hold an ounce of pessimism over forecasts which predict EUR-NOK reaching levels 10.1-10.2 in 12 months’ time. We will just have to patiently wait and watch. 

**The full derivation of the complex econometric model which is based upon the ‘Random Walk Model’ can be found in the paper: ‘Oil prices and exchange rates: Norwegian evidence’. 

Technical analysis: 

Figure 1: 

Considering a 1-month time frame, the oscillators are not very powerful momentum indicators in terms of giving a clear market signal. From figure 1 you can see that the RSI (14) has been stable between the upper and lower values of 70% and 30%, not clearing either threshold in the last month. The 1-month value of approximately 39% is very neutral further emphasising the lack of clarity in terms of buy/sell clear. Furthermore, the recent RSI fluctuations have no clear pattern highlighting the lack of usefulness. 

However, based on figure 1 and the technical data the other main oscillator, the MACD level (12, 26) is pointing towards a sell position with an approximate value of -0.0034. This negative value shows that the 12-period EMA (blue) is generally below the 26-period EMA (orange) which indicates a bullish outlook. Although this suggests a sell it is not a strong sell since the absolute MACD value is so small and hence not definitive. We can see this in figure 1 as in July and June, the 12 period EMA has only been very minimally above the 26-period EMA and the histograms above the baseline being so small. Generally, there has been a lot of crossovers between the two EMA lines since June pointing to a less clear buy/sell position.  

Figure 2  

Whilst the oscillators give less of a powerful indication, the moving averages give a slightly more suggestive outlook with the EMA (10-50) and SMA (10-50) both pointing in the sell direction hence we get a stronger sell recommendation from the moving averages.  

Looking at the candlesticks in figure 2 between Jan 2020 and mid-March 2020, this period was marked by continuous market downtrend in line with the bullish outlook, since the candlesticks lie below the EMA line. However, since we have seen greater fluctuations between downtrend and uptrend. Late April to mid-May was marked by continuous market uptrend with the candlesticks lying above the moving average but June and July have been marked with incredible fluctuation and we may see some consolidation of the NOK at around a value of 0.0900 and 0.09500 to the Euro.  

Outlook: 

In the short term, the outlook is very unclear based on the technical analysis above which suggests a neutral investment position due to the continuous incremental fluctuations.  

In the long term, there is evidence to suggest that the NOK will consolidate maybe even appreciate due to easing out of covid pressures and increasing demand for oil, hence the recommendation to the risk averse investor would be again a neutral position as both economies recover (EU recovery fund).  

But for the more opportune investor a recommendation would be to long the NOK as it has shown signs of recovery in recent weeks. Amalgamated with Norway’s strong financial record with a low amount of government debt and a sovereign fund to rely on, Norges clearly have the tools and backing to combat the currency’s struggles caused by Covid-19. 

Finally, as the crux of the pandemic appears to be behind us, commodities analysts at ING have predicted the worst of the disruption in the oil market is behind us, therefore enabling stability and reduced volatility to prevail in the oil and refinery market in Norway. ING also mentioned that NOK is rated as one of the highest currencies globally for correlation with steeper yield curves in recovery phases, indicating its potential to recover from its devaluation.   

There is scope for the EUR-NOK to edge back and hopefully in six months, it will reach a sustainable level of 10.35 – 10.15. 

Jargon-busting: 

• Covariance – Covariance measures the directional relationship between the returns on two assets. 
• EMA (10-50) – The Exponential Moving Average (between a 10-day all the way to a 50-day period) is a moving average that places a greater weight and significance on the most recent data points. It is another type of indicator and is used to produce buy and sell signals based on crossovers and divergences from the historical average. 
• F-loan – The F-loan is the primary instrument used to provide liquidity to the banking system of Norway where the Central Bank reduces the quantity of reserves it holds in order to fund the scheme 
• MACD level (12, 26) – The Moving Average Convergence Divergence, another oscillator indicator, is calculated by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA. The MACD triggers technical signals when it crosses above (to buy) or below (to sell) its signal line and the speed of crossovers is also taken as a signal of a market is overbought or oversold. 

• Momentum indicators – tools utilized by traders to measure the speed or velocity of price changes of a given security 
• Norges – This is the Central Banking body of Norway 
• Oscillator – Oscillators are momentum indicators, whose fluctuations are bounded by some upper and lower band. If the values approach the upper band, this signals overbuying and if they approach the lower band, this suggests oversold signals. 
• RSI (14) – The Relative Strength Index (14) is a momentum oscillator over 14 periods which provides traders with signals about bullish and bearish price momentum. An asset is usually considered overbought when the RSI value is above 70% and oversold when it is below 30%. 
• SMA (10-50) – The Simple Moving Average (between a 10-day all the way up to a 50-day period) is another technical indicator that calculates the average of a selected range of prices, usually closing prices, by the number of periods in that range. It can help determine if an asset price will continue or reverse. 

• Sovereign Fund – A sovereign fund is a state-owned pool of money that is invested in various financial assets such as foreign exchange, stocks, commodities and pension contributions 

References 

1. Akram, F., 2002. Oil Price and Exchange Rate: Norwegian Evidence. Econometrics Journal, [online] 7, pp.476-480. Available from: https://www.jstor.org/stable/23115035?read-now=1&seq=1 [Accessed 30 Jul. 2020]. 

2. Ambrose, J., 2020. Oil prices dip below zero as producers forced to pay to dispose of excess. [online] the Guardian. Available from: https://www.theguardian.com/world/2020/apr/20/oil-prices-sink-to-20-year-low-as-un-sounds-alarm-on-to-covid-19-relief-fund [Accessed 31 Jul. 2020]. 

3. Anon, 2020. ECB euro reference exchange rate: Norwegian krone (NOK). [online] European Central Bank. Available from: https://www.ecb.europa.eu/stats/policy_and_exchange_rates/euro_reference_exchange_rates/html/eurofxref-graph-nok.en.html [Accessed 29 Jul. 2020]. 

4. Anon, 2020. Global oil demand to decline in 2020 as coronavirus weighs heavily on markets – News – IEA. [online] IEA. Available from: https://www.iea.org/news/global-oil-demand-to-decline-in-2020-as-coronavirus-weighs-heavily-on-markets [Accessed 30 Jul. 2020]. 

5. Anon, 2020. Norwegian Krone | 1992-2020 Data | 2021-2022 Forecast | Quote | Chart | Historical. [online] Tradingeconomics.com. Available from: https://tradingeconomics.com/norway/currency [Accessed 29 Jul. 2020]. 

6. Anon, 2020. Norwegian Krone: Expected To Strengthen Against The Greenback. [online] Available from: https://seekingalpha.com/article/4355631-norwegian-krone-expected-to-strengthen-against-greenback [Accessed 31 Jul. 2020]. 

7. Anon, 2020. What’s Ailing Norway’s Krone? – CME Group. [online] Cmegroup.com. Available from: https://www.cmegroup.com/education/featured-reports/whats-ailing-norways-krone.html#:~:text=When%20seen%20from%20a%20US,value%20of%20other%20European%20currencies. [Accessed 31 Jul. 2020]. 

8. Elam, Y., 2020. Norwegian Krone crashes to multi-year lows vs. dollar, euro alongside oil amid the coronavirus crisis. [online] FXStreet. Available from: https://www.fxstreet.com/news/norwegian-krone-crashes-to-multi-year-lows-vs-dollar-euro-alongside-oil-amid-the-coronavirus-crisis-202003091618 [Accessed 30 Jul. 2020]. 

9. Evans, O., 2020. Oil price collapse hits Norwegian krone hard. [online] SalmonBusiness. Available from: https://salmonbusiness.com/oil-price-collapse-hits-norwegian-krone-hard/#:~:text=Oil%20prices%20plummet%20and%20the%20Norwegian%20krone%20depreciates%20sharply.&text=For%20an%20oil%2Dheavy%20currency,to%2012.91%20against%20Norwegian%20kroner. [Accessed 31 Jul. 2020]. 

10. Messelt, D., 2019. The weakness of the Norwegian krone – Real NOK exchange rate – Alfred Berg. [online] Alfred Berg Corpo. Available from: https://www.alfredberg.com/the-weakness-of-the-norwegian-krone-real-nok-exchange-rate/ [Accessed 31 Jul. 2020]. 

11. Milne, R., 2020. Norway considers action to break ‘extraordinary’ krone slide. Financial Times, [online] p.6. Available from: https://www.ft.com/content/e2ef5144-69c9-11ea-800d-da70cff6e4d3 [Accessed 31 Jul. 2020]. 

12. Nyaga, C., 2020. Norwegian krone momentum continues on Norges bank actions. [online] Invezz. Available from: https://invezz.com/news/2020/04/02/norwegian-krone-rises-against-dollar-and-euro-coronavirus/ [Accessed 31 Jul. 2020]. 

13. Smith, J. and Krpata, P., 2020. It’s all about liquidity for NOK, despite Norges Bank rate cut. [online] Available from: https://think.ing.com/snaps/its-all-about-liquidity-for-nok-despite-norges-bank-rate-cut/ [Accessed 31 Jul. 2020]. 

14. TradingView. 2020. Technical Analysis Of NORWEGIAN KRONE / EURO (FX_IDC:NOKEUR) — Tradingview — UK. [online] Available at: <https://uk.tradingview.com/symbols/NOKEUR/technicals/&gt; [Accessed 31 July 2020]. 

15. Investopedia. 2020. Technical Analysis Of Stocks And Trends. [online] Available at: <https://www.investopedia.com/terms/t/technical-analysis-of-stocks-and-trends.asp&gt; [Accessed 31 July 2020].