Mid-Week Report: Dollar Rally Beginning

We're easing back into the complete analysis of the markets simply because of how much time it takes to validate and prove every case AND publish the data and commentary.  That will largely be reserved for the monthly newsletter.  The blog will contain shorter term summary information.

In summary, overextended markets, cyclical work, and sentiment point to a correction with a minor dollar rally and minor stock pullback.  Only if Helicopter Ben disappoints will we have a dramatic correction.  Ben has created a real mess.  The fundamental story is simple enough: if the Fed doesn't continue to pump money, the economy craters and every politician will be hanging from lamp posts within a couple of years.  Expect MASSIVE civil unrest.  (Note: Europe is in the same situation, and due to "austerity" measures, the path to massive unrest is virtually baked in the cake.)  However, if the Fed pumps enough money to support asset prices and give "Keynesian hope" to the masses, then the dollar will crash and the likelihood of MASSIVE civil unrest comes about again.  There is no escaping this trap--only the means by which things break is up in the air, and that, my friends, is what we're trying to keep an eye on.

Short term, we expect a rally in the dollar and a corresponding correction in stocks/commodities/gold.  This trend has just started as we speak.  However, mid and longer term, the song remains the same.  We believe it highly unlikely that the currency of any country will be preserved over its economy.  No politician will have that.  The fault is in government, as it always is.

November 3 is the big day to determine just how much money will be printed in QE2.  The Fed is already realizing that leaking information about QE2 can only set the market up for disappointment.  $500B+ is already baked into asset prices--anything less is a disappointment.  At the same time, the dollar has taken a beating and some economic indicators are better than expected.  Typically, this should be a signal for the Fed to do nothing--but they've set the expectation of QE2 already and cannot afford to do nothing.  What a tangled web we weave...

It is our opinion that we are now witnessing the Fed, by way of the Wall Street Journal, attempting to talk the markets down and reset expectations before next week so the disappointment is not so high.  The Fed has used the term "few hundred billion" in regards to the amount of QE2.  We expect weak markets going into Nov 3 and then an announcement of $500B or more to try and goose the markets on "higher expectations relative to the lower expectations we set a week ago following the massively high expectations we set the month before that."   Phew.  Confused yet?  Imagine how confused the Fed must be...

Today's analysis will focus largely on the dollar and gold...

The dollar/asset correlation conundrum (DACC) is high, which we've been commenting on since before commenting on it was cool...

The implication is dollar up/assets down and vice versa.  Considering that any move in the dollar here is not out of fear (like the credit crisis or the European debt crisis) but is out of short term expectations, we anticipate that any rally will be minor with correspondingly minor moves in gold to the downside.  Longer term charts provide a clearer picture.

Of note is the symmetrical pattern denoted by the orange lines.  Longer term, that must be watched for clues as to what's next.  Any rally in the dollar should not exceed the 84 region--if it does, then panic will set in.  A break above that triangle will take the dollar to roughly 102--likely a long term bull market.  We expect the Fed to fight this trend.  As such, eventually we may see the dollar break below the triangle with a target of roughly 58 over the next year or two.  Note that the MACD is pointing toward a rally.  This is worth watching as momentum is rising, not falling.

Weekly view:

Weekly is clearly showing oversold stochastic, a near-oversold RSI, and a strong trendline.  Watch for a MACD buy signal as momentum has clearly started rising.  A rally here would be several weeks to a couple of months long--supporting the thesis of a move toward the 84 level.

The daily shows momentum has shifted to be dollar positive, and supports a rally up to 84.  What's not shown is that the trend is weakening as the dollar is rising--that's a divergence that shows a change could be fast and sudden.

Our own cyclical look at the UUP, the ETF that tracks the USD, shows a positive turn.

If this move is going to be substantial, we should see a rally that trends for some time.  Here are the scenarios we're watching:

1. Dollar rallies into Fed meeting.  Fed outperforms.  Dollar turns negative on cyclical top.
2. Dollar rallies into Fed meeting.  Fed underperforms.  Dollar rises in trending fashion toward 84 over next couple of months.

We'll see what happens.

The implication is that, on the gold side of things, there's a likely buying opportunity coming up.  How low will gold go?  That's for next time...

If you haven't purchased any physical gold yet, you may want to take advantage of this pullback.  We expect a minor pullback here and an intermediate term pullback next year.  As part of our first newsletter, we will outline our expectations and why.  In addition, if you're concerned with gold confiscation, we have become very familiar with a rock-solid plan for allocated gold investment in a Swiss vault--one that will actually take American customers--and one that will allow for easy pick-up or delivery.  Contact us for details--we will not publish that information on the blog.